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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Vikas EcoTech Limited’s (NSE:VIKASECO) P/E ratio and reflect on what it tells us about the company’s share price. Vikas EcoTech has a P/E ratio of 14.59, based on the last twelve months. In other words, at today’s prices, investors are paying ₹14.59 for every ₹1 in prior year profit.

See our latest analysis for Vikas EcoTech

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Vikas EcoTech:

P/E of 14.59 = ₹11.2 ÷ ₹0.77 (Based on the trailing twelve months to September 2018.)

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 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. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

Vikas EcoTech’s earnings per share fell by 25% in the last twelve months. But it has grown its earnings per share by 36% per year over the last five years.

How Does Vikas EcoTech’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below Vikas EcoTech has a P/E ratio that is fairly close for the average for the chemicals industry, which is 15.6.

Vikas EcoTech’s P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.

Remember: P/E Ratios Don’t Consider The Balance Sheet

Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Vikas EcoTech’s Debt Impact Its P/E Ratio?

Net debt totals 35% of Vikas EcoTech’s market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Verdict On Vikas EcoTech’s P/E Ratio

Vikas EcoTech trades on a P/E ratio of 14.6, which is below the IN market average of 16.3. Since it only carries a modest debt load, it’s likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 Vikas EcoTech. 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).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.