Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Harita Seating Systems Limited's (NSE:HARITASEAT) P/E ratio could help you assess the value on offer. Harita Seating Systems has a P/E ratio of 9.6, based on the last twelve months. That corresponds to an earnings yield of approximately 10%.

View our latest analysis for Harita Seating Systems

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Harita Seating Systems:

P/E of 9.6 = ₹355.75 ÷ ₹37.06 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Harita Seating Systems Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Harita Seating Systems has a lower P/E than the average (12.6) in the auto components industry classification.

This suggests that market participants think Harita Seating Systems will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

Harita Seating Systems saw earnings per share decrease by 23% last year. But EPS is up 30% over the last 5 years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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.

Is Debt Impacting Harita Seating Systems's P/E?

Harita Seating Systems's net debt is 8.0% of its market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Verdict On Harita Seating Systems's P/E Ratio

Harita Seating Systems's P/E is 9.6 which is below average (13.8) in the IN market. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Harita Seating Systems. 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.