This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how TCNS Clothing Co. Limited’s (NSE:TCNSBRANDS) P/E ratio could help you assess the value on offer. Based on the last twelve months, TCNS Clothing’s P/E ratio is 38.37. That is equivalent to an earnings yield of about 2.6%.

See our latest analysis for TCNS Clothing

How Do You Calculate TCNS Clothing’s P/E Ratio?

The formula for price to earnings is:

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

Or for TCNS Clothing:

P/E of 38.37 = ₹683.35 ÷ ₹17.81 (Based on the year to September 2018.)

Is A High Price-to-Earnings 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. 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.’

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. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. 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 TCNS Clothing grew EPS by a stonking 89% in the last year. And its annual EPS growth rate over 5 years is 42%. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does TCNS Clothing’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 TCNS Clothing has a higher P/E than the average (13.2) P/E for companies in the luxury industry.

That means that the market expects TCNS Clothing will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. 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. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Is Debt Impacting TCNS Clothing’s P/E?

TCNS Clothing has net cash of ₹870m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On TCNS Clothing’s P/E Ratio

TCNS Clothing’s P/E is 38.4 which is above average (17.1) in the IN market. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free visual report on analyst forecasts could hold they key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.