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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Vishnu Chemicals Limited's (NSE:VISHNU) P/E ratio could help you assess the value on offer. Vishnu Chemicals has a price to earnings ratio of 7.56, based on the last twelve months. That is equivalent to an earnings yield of about 13%.
View our latest analysis for Vishnu Chemicals
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 Vishnu Chemicals:
P/E of 7.56 = ₹154.2 ÷ ₹20.4 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
In the last year, Vishnu Chemicals grew EPS like Taylor Swift grew her fan base back in 2010; the 69% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 21% is also impressive. So I'd be surprised if the P/E ratio was not above average.
Does Vishnu Chemicals 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. The image below shows that Vishnu Chemicals has a lower P/E than the average (15.1) P/E for companies in the chemicals industry.
Vishnu Chemicals's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Vishnu Chemicals, 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.
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. 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).