Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Menon Bearings Limited's (NSE:MENONBE) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Menon Bearings's P/E ratio is 15.71. That corresponds to an earnings yield of approximately 6.4%.

View our latest analysis for Menon Bearings

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Menon Bearings:

P/E of 15.71 = ₹70.85 ÷ ₹4.51 (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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

Does Menon Bearings 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. You can see in the image below that the average P/E (13.9) for companies in the auto components industry is lower than Menon Bearings's P/E.

That means that the market expects Menon Bearings will outperform other companies in its industry. 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.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

It's great to see that Menon Bearings grew EPS by 20% in the last year. And earnings per share have improved by 33% annually, over the last five years. With that performance, you might expect an above average P/E ratio.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.

Menon Bearings's Balance Sheet

Net debt totals just 6.9% of Menon Bearings's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Menon Bearings's P/E Ratio

Menon Bearings's P/E is 15.7 which is about average (14.8) in the IN market. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but 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 Menon Bearings. 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.