This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Gulshan Polyols Limited's (NSE:GULPOLY) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Gulshan Polyols has a P/E ratio of 9.5. In other words, at today's prices, investors are paying ₹9.5 for every ₹1 in prior year profit.

View our latest analysis for Gulshan Polyols

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Gulshan Polyols:

P/E of 9.5 = ₹44.95 ÷ ₹4.73 (Based on the year 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 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 Gulshan Polyols 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. We can see in the image below that the average P/E (11.1) for companies in the chemicals industry is higher than Gulshan Polyols's P/E.

Gulshan Polyols'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. 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.

Gulshan Polyols's earnings per share grew by -7.4% in the last twelve months. But earnings per share are down 4.6% per year over the last five years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

So What Does Gulshan Polyols's Balance Sheet Tell Us?

Gulshan Polyols's net debt equates to 42% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Bottom Line On Gulshan Polyols's P/E Ratio

Gulshan Polyols's P/E is 9.5 which is below average (13.1) in the IN market. The company does have a little debt, and EPS is moving in the right direction. The P/E ratio implies the market is cautious about longer term prospects.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' Although we don't have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Gulshan Polyols. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.