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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Kritika Wires Limited's (NSE:KRITIKA) P/E ratio could help you assess the value on offer. Kritika Wires has a price to earnings ratio of 7.92, based on the last twelve months. That means that at current prices, buyers pay ₹7.92 for every ₹1 in trailing yearly profits.
See our latest analysis for Kritika Wires
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 Kritika Wires:
P/E of 7.92 = ₹35 ÷ ₹4.42 (Based on the trailing twelve months to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Kritika Wires increased earnings per share by an impressive 13% over the last twelve months. And it has bolstered its earnings per share by 34% per year over the last five years. This could arguably justify a relatively high P/E ratio.
How Does Kritika Wires's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Kritika Wires has a lower P/E than the average (10.4) in the metals and mining industry classification.
This suggests that market participants think Kritika Wires will underperform other companies in its industry. Since the market seems unimpressed with Kritika Wires, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. 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.