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 Total Transport Systems Limited's (NSE:TOTAL) P/E ratio could help you assess the value on offer. Based on the last twelve months, Total Transport Systems's P/E ratio is 5.84. That means that at current prices, buyers pay ₹5.84 for every ₹1 in trailing yearly profits.

See our latest analysis for Total Transport Systems

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Total Transport Systems:

P/E of 5.84 = ₹31 ÷ ₹5.31 (Based on the year to March 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.

Does Total Transport Systems 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. We can see in the image below that the average P/E (18.2) for companies in the logistics industry is higher than Total Transport Systems's P/E.

Its relatively low P/E ratio indicates that Total Transport Systems shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Total Transport Systems saw earnings per share decrease by 15% last year. And it has shrunk its earnings per share by 11% per year over the last five years. This might lead to muted expectations.

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.