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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use GP Petroleums Limited's (NSE:GULFPETRO) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, GP Petroleums's P/E ratio is 18.43. That corresponds to an earnings yield of approximately 5.4%.
See our latest analysis for GP Petroleums
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for GP Petroleums:
P/E of 18.43 = ₹58.8 ÷ ₹3.19 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
GP Petroleums had pretty flat EPS growth in the last year. But it has grown its earnings per share by 73% per year over the last five years.
Does GP Petroleums Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (11.8) for companies in the oil and gas industry is lower than GP Petroleums's P/E.
GP Petroleums's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.