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Thirumalai Chemicals (NSE:TIRUMALCHM) shareholders are no doubt pleased to see that the share price has had a great month, posting a 32% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 47% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
View our latest analysis for Thirumalai Chemicals
Does Thirumalai Chemicals Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 8.02 that sentiment around Thirumalai Chemicals isn't particularly high. If you look at the image below, you can see Thirumalai Chemicals has a lower P/E than the average (11.2) in the chemicals industry classification.
Thirumalai Chemicals's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. Then, a lower P/E should attract more buyers, pushing the share price up.
Thirumalai Chemicals shrunk earnings per share by 44% over the last year. But EPS is up 48% over the last 5 years.
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. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).