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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Ipca Laboratories Limited's (NSE:IPCALAB), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Ipca Laboratories has a P/E ratio of 26.21. That is equivalent to an earnings yield of about 3.8%.

View our latest analysis for Ipca Laboratories

How Do You Calculate Ipca Laboratories's P/E Ratio?

The formula for price to earnings is:

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

Or for Ipca Laboratories:

P/E of 26.21 = ₹917.5 ÷ ₹35.01 (Based on the trailing twelve months to March 2019.)

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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

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. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Ipca Laboratories's 85% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 68% annually, over the last three years. So you might say it really deserves to have an above-average P/E ratio. On the other hand, the longer term performance is poor, with EPS down 1.6% per year over 5 years.

Does Ipca Laboratories Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Ipca Laboratories has a higher P/E than the average (18.3) P/E for companies in the pharmaceuticals industry.

Ipca Laboratories's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.