This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Venky’s (India) Limited’s (NSE:VENKYS) P/E ratio and reflect on what it tells us about the company’s share price. Venky’s (India) has a price to earnings ratio of 16.64, based on the last twelve months. That means that at current prices, buyers pay ₹16.64 for every ₹1 in trailing yearly profits.

Check out our latest analysis for Venky’s (India)

How Do I Calculate Venky’s (India)’s Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Venky’s (India):

P/E of 16.64 = ₹2329.05 ÷ ₹139.96 (Based on the trailing twelve months to September 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Most would be impressed by Venky’s (India) earnings growth of 21% in the last year. And its annual EPS growth rate over 5 years is 50%. This could arguably justify a relatively high P/E ratio.

How Does Venky’s (India)’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Venky’s (India) has a lower P/E than the average (18.2) in the food industry classification.

This suggests that market participants think Venky’s (India) will underperform other companies in its industry. Since the market seems unimpressed with Venky’s (India), it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Venky’s (India)’s Balance Sheet

Venky’s (India)’s net debt is 1.1% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Bottom Line On Venky’s (India)’s P/E Ratio

Venky’s (India) has a P/E of 16.6. That’s around the same as the average in the IN market, which is 16.8. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Venky’s (India) 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.