This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Shalby Limited's (NSE:SHALBY), to help you decide if the stock is worth further research. Shalby has a price to earnings ratio of 20.97, based on the last twelve months. That is equivalent to an earnings yield of about 4.8%.

See our latest analysis for Shalby

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Shalby:

P/E of 20.97 = ₹84.05 ÷ ₹4.01 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

Does Shalby Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Shalby has a P/E ratio that is roughly in line with the healthcare industry average (21.8).

Shalby's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Shalby actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

Shalby's 62% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Regrettably, the longer term performance is poor, with EPS down 2.1% per year over 5 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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 investing in growth. That means taking on debt (or spending its 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.

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

Shalby has net cash of ₹348m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Shalby's P/E Ratio

Shalby trades on a P/E ratio of 21, which is above its market average of 13.4. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.

But note: Shalby 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.