This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to MPS Limited's (NSE:MPSLTD), to help you decide if the stock is worth further research. Based on the last twelve months, MPS's P/E ratio is 11.36. In other words, at today's prices, investors are paying ₹11.36 for every ₹1 in prior year profit.

See our latest analysis for MPS

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for MPS:

P/E of 11.36 = ₹464.5 ÷ ₹40.89 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each ₹1 the company has earned over the last year. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does MPS'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 MPS has a lower P/E than the average (12.5) in the media industry classification.

Its relatively low P/E ratio indicates that MPS shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with MPS, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's great to see that MPS grew EPS by 17% in the last year. And it has bolstered its earnings per share by 4.9% per year over the last five years. This could arguably justify a relatively high P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.