This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Eris Lifesciences Limited's (NSE:ERIS), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Eris Lifesciences has a P/E ratio of 19.41. In other words, at today's prices, investors are paying ₹19.41 for every ₹1 in prior year profit.

View our latest analysis for Eris Lifesciences

How Do I Calculate Eris Lifesciences's Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Eris Lifesciences:

P/E of 19.41 = ₹428.55 ÷ ₹22.08 (Based on the year to June 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does Eris Lifesciences's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Eris Lifesciences has a higher P/E than the average (16.1) P/E for companies in the pharmaceuticals industry.

That means that the market expects Eris Lifesciences will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Eris Lifesciences saw earnings per share improve by -3.1% last year. And its annual EPS growth rate over 5 years is 34%.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Is Debt Impacting Eris Lifesciences's P/E?

Since Eris Lifesciences holds net cash of ₹1.6b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Eris Lifesciences's P/E Ratio

Eris Lifesciences trades on a P/E ratio of 19.4, which is above its market average of 13.8. Earnings improved over the last year. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Eris Lifesciences. So you may wish to see this free collection of other companies that have grown earnings strongly.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.