This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how TVS Electronics Limited’s (NSE:TVSELECT) P/E ratio could help you assess the value on offer. Based on the last twelve months, TVS Electronics’s P/E ratio is 23.14. That means that at current prices, buyers pay ₹23.14 for every ₹1 in trailing yearly profits.

View our latest analysis for TVS Electronics

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for TVS Electronics:

P/E of 23.14 = ₹200.75 ÷ ₹8.68 (Based on the year to March 2018.)

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 Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. 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.

TVS Electronics increased earnings per share by a whopping 185% last year. And earnings per share have improved by 60% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.

How Does TVS Electronics’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, TVS Electronics has a higher P/E than the average company (10.9) in the tech industry.

That means that the market expects TVS Electronics will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Remember: P/E Ratios Don’t Consider The Balance Sheet

The ‘Price’ in P/E reflects the market capitalization of the company. 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.

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.

How Does TVS Electronics’s Debt Impact Its P/E Ratio?

Since TVS Electronics holds net cash of ₹364m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On TVS Electronics’s P/E Ratio

TVS Electronics trades on a P/E ratio of 23.1, which is above the IN market average of 17.2. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. Therefore it seems reasonable that the market would have relatively high expectations of the company

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don’t have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

But note: TVS Electronics may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.