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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Ajanta Pharma Limited's (NSE:AJANTPHARM) P/E ratio could help you assess the value on offer. What is Ajanta Pharma's P/E ratio? Well, based on the last twelve months it is 22.78. That is equivalent to an earnings yield of about 4.4%.
See our latest analysis for Ajanta Pharma
How Do You Calculate Ajanta Pharma's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Ajanta Pharma:
P/E of 22.78 = ₹1001.65 ÷ ₹43.97 (Based on the trailing twelve months to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each ₹1 the company has earned over the last year. 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
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Ajanta Pharma's earnings per share fell by 17% in the last twelve months. But it has grown its earnings per share by 11% per year over the last five years. And it has shrunk its earnings per share by 2.4% per year over the last three years. This could justify a low P/E.
How Does Ajanta Pharma's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Ajanta Pharma has a higher P/E than the average (18.8) P/E for companies in the pharmaceuticals industry.
That means that the market expects Ajanta Pharma will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.