In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how NCL Industries Limited's (NSE:NCLIND) P/E ratio could help you assess the value on offer. NCL Industries has a price to earnings ratio of 7.47, based on the last twelve months. That is equivalent to an earnings yield of about 13%.
Check out our latest analysis for NCL Industries
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for NCL Industries:
P/E of 7.47 = ₹114.95 ÷ ₹15.38 (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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does NCL Industries Have A Relatively High Or Low P/E For Its Industry?
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 NCL Industries has a lower P/E than the average (20.6) in the basic materials industry classification.
NCL Industries's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, NCL Industries grew EPS like Taylor Swift grew her fan base back in 2010; the 63% gain was both fast and well deserved. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 11%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. 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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.