The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Orient Abrasives Limited's (NSE:ORIENTABRA), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Orient Abrasives has a P/E ratio of 11.69. That means that at current prices, buyers pay ₹11.69 for every ₹1 in trailing yearly profits.
Check out our latest analysis for Orient Abrasives
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Orient Abrasives:
P/E of 11.69 = ₹17.65 ÷ ₹1.51 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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.
Does Orient Abrasives Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Orient Abrasives has a higher P/E than the average (8.8) P/E for companies in the metals and mining industry.
Orient Abrasives's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
It's great to see that Orient Abrasives grew EPS by 11% in the last year. And its annual EPS growth rate over 5 years is 21%. This could arguably justify a relatively high P/E ratio. Unfortunately, earnings per share are down 8.4% a year, over 3 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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.