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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at DFM Foods Limited's (NSE:DFM) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, DFM Foods's P/E ratio is 36.58. That is equivalent to an earnings yield of about 2.7%.
View our latest analysis for DFM Foods
How Do I Calculate DFM Foods's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for DFM Foods:
P/E of 36.58 = ₹239.25 ÷ ₹6.54 (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 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
It's nice to see that DFM Foods grew EPS by a stonking 40% in the last year. And earnings per share have improved by 36% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does DFM Foods's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, DFM Foods has a higher P/E than the average company (17) in the food industry.
That means that the market expects DFM Foods will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.