In This Article:
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 Torrent Power Limited's (NSE:TORNTPOWER) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Torrent Power has a P/E ratio of 14.20. In other words, at today's prices, investors are paying ₹14.20 for every ₹1 in prior year profit.
Check out our latest analysis for Torrent Power
How Do I Calculate Torrent Power's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Torrent Power:
P/E of 14.20 = ₹280.15 ÷ ₹19.73 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Torrent Power's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (14.2) for companies in the electric utilities industry is roughly the same as Torrent Power's P/E.
Its P/E ratio suggests that Torrent Power shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Torrent Power actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Torrent Power's earnings per share fell by 1.8% in the last twelve months. But it has grown its earnings per share by 36% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. 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).