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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Munjal Showa Limited's (NSE:MUNJALSHOW), to help you decide if the stock is worth further research. Based on the last twelve months, Munjal Showa's P/E ratio is 8.67. That means that at current prices, buyers pay ₹8.67 for every ₹1 in trailing yearly profits.
See our latest analysis for Munjal Showa
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 Munjal Showa:
P/E of 8.67 = ₹167.5 ÷ ₹19.33 (Based on the trailing twelve months to December 2018.)
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. 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 Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
It's nice to see that Munjal Showa grew EPS by a stonking 35% in the last year. And earnings per share have improved by 1.1% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
How Does Munjal Showa'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. If you look at the image below, you can see Munjal Showa has a lower P/E than the average (15.7) in the auto components industry classification.
Its relatively low P/E ratio indicates that Munjal Showa shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Munjal Showa, 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.
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).