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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Fine Organic Industries Limited's (NSE:FINEORG) P/E ratio to inform your assessment of the investment opportunity. Fine Organic Industries has a P/E ratio of 34.1, based on the last twelve months. That is equivalent to an earnings yield of about 2.9%.
Check out our latest analysis for Fine Organic Industries
How Do You Calculate Fine Organic Industries's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Fine Organic Industries:
P/E of 34.1 = ₹1432.1 ÷ ₹42 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each ₹1 of company 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.'
How Does Fine Organic Industries's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (11.2) for companies in the chemicals industry is a lot lower than Fine Organic Industries's P/E.
Its relatively high P/E ratio indicates that Fine Organic Industries shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Most would be impressed by Fine Organic Industries earnings growth of 22% in the last year. And it has bolstered its earnings per share by 15% per year over the last five years. With that performance, you might expect an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.