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 Ambuja Cements Limited's (NSE:AMBUJACEM) P/E ratio to inform your assessment of the investment opportunity. Ambuja Cements has a price to earnings ratio of 17.17, based on the last twelve months. That means that at current prices, buyers pay ₹17.17 for every ₹1 in trailing yearly profits.

See our latest analysis for Ambuja Cements

How Do You Calculate Ambuja Cements's P/E Ratio?

The formula for price to earnings is:

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

Or for Ambuja Cements:

P/E of 17.17 = ₹205.8 ÷ ₹11.99 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Does Ambuja Cements's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see Ambuja Cements has a lower P/E than the average (19.5) in the basic materials industry classification.

Its relatively low P/E ratio indicates that Ambuja Cements shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

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 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.

Ambuja Cements's 50% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 30% annually, over the last three years. So you might say it really deserves to have an above-average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does Ambuja Cements's Debt Impact Its P/E Ratio?

Ambuja Cements has net cash of ₹70b. This is fairly high at 17% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Ambuja Cements's P/E Ratio

Ambuja Cements has a P/E of 17.2. That's higher than the average in its market, which is 13.4. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Ambuja Cements to have a high P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Ambuja Cements may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.