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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use CEAT Limited's (NSE:CEATLTD) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, CEAT has a P/E ratio of 15.36. That means that at current prices, buyers pay ₹15.36 for every ₹1 in trailing yearly profits.
Check out our latest analysis for CEAT
How Do You Calculate CEAT's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for CEAT:
P/E of 15.36 = ₹958 ÷ ₹62.35 (Based on the trailing twelve months to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. 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
If earnings fall then in the future the 'E' will be lower. 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.
CEAT's earnings per share grew by -6.0% in the last twelve months. But earnings per share are down 4.0% per year over the last five years.
Does CEAT 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 CEAT has a P/E ratio that is roughly in line with the auto components industry average (15.3).
CEAT's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.