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 Focus Lighting and Fixtures Limited’s (NSE:FOCUS) P/E ratio could help you assess the value on offer. Based on the last twelve months, Focus Lighting and Fixtures’s P/E ratio is 6.98. In other words, at today’s prices, investors are paying ₹6.98 for every ₹1 in prior year profit.
See our latest analysis for Focus Lighting and Fixtures
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 Focus Lighting and Fixtures:
P/E of 6.98 = ₹125.65 ÷ ₹18 (Based on the trailing twelve months to March 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s great to see that Focus Lighting and Fixtures grew EPS by 20% in the last year. And its annual EPS growth rate over 5 years is 39%. With that performance, you might expect an above average P/E ratio.
How Does Focus Lighting and Fixtures’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Focus Lighting and Fixtures has a lower P/E than the average (15.7) P/E for companies in the electrical industry.
This suggests that market participants think Focus Lighting and Fixtures will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. 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.