This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Vaishali Pharma Limited’s (NSE:VAISHALI) P/E ratio to inform your assessment of the investment opportunity. Vaishali Pharma has a P/E ratio of 37.41, based on the last twelve months. That means that at current prices, buyers pay ₹37.41 for every ₹1 in trailing yearly profits.

View our latest analysis for Vaishali Pharma

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Vaishali Pharma:

P/E of 37.41 = ₹52.75 ÷ ₹1.41 (Based on the trailing twelve months to March 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

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. 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.

Vaishali Pharma shrunk earnings per share by 40% over the last year. But EPS is up 46% over the last 3 years. And EPS is down 1.0% a year, over the last 5 years. This could justify a pessimistic P/E.

How Does Vaishali Pharma’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Vaishali Pharma has a higher P/E than the average (20.6) P/E for companies in the pharmaceuticals industry.

Vaishali Pharma’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

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 taking on debt (or spending its remaining cash).

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 Vaishali Pharma’s P/E?

Vaishali Pharma has net debt worth 52% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Verdict On Vaishali Pharma’s P/E Ratio

Vaishali Pharma’s P/E is 37.4 which is above average (17.3) in the IN market. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. We don’t have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

But note: Vaishali Pharma 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.