Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Gulf Oil Lubricants India Limited's (NSE:GULFOILLUB) P/E ratio to inform your assessment of the investment opportunity. Gulf Oil Lubricants India has a price to earnings ratio of 21.46, based on the last twelve months. That is equivalent to an earnings yield of about 4.7%.

View our latest analysis for Gulf Oil Lubricants India

How Do You Calculate Gulf Oil Lubricants India's P/E Ratio?

The formula for P/E is:

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

Or for Gulf Oil Lubricants India:

P/E of 21.46 = ₹803.35 ÷ ₹37.44 (Based on the trailing twelve months 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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

Does Gulf Oil Lubricants India Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Gulf Oil Lubricants India has a higher P/E than the average company (11.7) in the chemicals industry.

That means that the market expects Gulf Oil Lubricants India will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Gulf Oil Lubricants India increased earnings per share by an impressive 13% over the last twelve months. And earnings per share have improved by 19% annually, over the last three years. So one might expect an above average P/E ratio.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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).

So What Does Gulf Oil Lubricants India's Balance Sheet Tell Us?

Gulf Oil Lubricants India has net cash of ₹104m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Gulf Oil Lubricants India's P/E Ratio

Gulf Oil Lubricants India's P/E is 21.5 which is above average (13.6) in its market. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it does not seem strange that the P/E is above average.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Gulf Oil Lubricants India. 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.