In This Article:
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 HIL Limited's (NSE:HIL) P/E ratio could help you assess the value on offer. HIL has a P/E ratio of 9.14, based on the last twelve months. That corresponds to an earnings yield of approximately 10.9%.
See our latest analysis for HIL
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 HIL:
P/E of 9.14 = ₹1100.60 ÷ ₹120.46 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.
Does HIL Have A Relatively High Or Low P/E For Its Industry?
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 HIL has a lower P/E than the average (16.5) in the basic materials industry classification.
Its relatively low P/E ratio indicates that HIL shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
HIL shrunk earnings per share by 6.3% last year. But EPS is up 27% over the last 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
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.