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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Zuari Agro Chemicals Limited’s (NSE:ZUARI) P/E ratio and reflect on what it tells us about the company’s share price. Zuari Agro Chemicals has a price to earnings ratio of 9.07, based on the last twelve months. That means that at current prices, buyers pay ₹9.07 for every ₹1 in trailing yearly profits.
See our latest analysis for Zuari Agro Chemicals
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 Zuari Agro Chemicals:
P/E of 9.07 = ₹235 ÷ ₹25.92 (Based on the trailing twelve months to September 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 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s nice to see that Zuari Agro Chemicals grew EPS by a stonking 103% in the last year. And earnings per share have improved by 52% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Zuari Agro Chemicals’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (17.1) for companies in the chemicals industry is higher than Zuari Agro Chemicals’s P/E.
This suggests that market participants think Zuari Agro Chemicals will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).