The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how 3i Infotech Limited’s (NSE:3IINFOTECH) P/E ratio could help you assess the value on offer. 3i Infotech has a P/E ratio of 9.66, based on the last twelve months. In other words, at today’s prices, investors are paying ₹9.66 for every ₹1 in prior year profit.
Check out our latest analysis for 3i Infotech
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 3i Infotech:
P/E of 9.66 = ₹3.34 ÷ ₹0.35 (Based on the trailing twelve months to September 2018.)
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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
3i Infotech saw earnings per share decrease by 35% last year. But EPS is up 32% over the last 5 years.
How Does 3i Infotech’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (16.3) for companies in the software industry is higher than 3i Infotech’s P/E.
This suggests that market participants think 3i Infotech will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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.
3i Infotech’s Balance Sheet
3i Infotech’s net debt is considerable, at 118% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.