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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 India Glycols Limited's (NSE:INDIAGLYCO) P/E ratio could help you assess the value on offer. India Glycols has a price to earnings ratio of 6.29, based on the last twelve months. That is equivalent to an earnings yield of about 16%.
See our latest analysis for India Glycols
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for India Glycols:
P/E of 6.29 = ₹269.35 ÷ ₹42.83 (Based on the year to March 2019.)
Is A High Price-to-Earnings 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
India Glycols increased earnings per share by a whopping 37% last year.
Does India Glycols 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 India Glycols has a lower P/E than the average (15.1) in the chemicals industry classification.
Its relatively low P/E ratio indicates that India Glycols shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with India Glycols, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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.