In This Article:
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use SRF Limited's (NSE:SRF) P/E ratio to inform your assessment of the investment opportunity. SRF has a price to earnings ratio of 23.8, based on the last twelve months. In other words, at today's prices, investors are paying ₹23.8 for every ₹1 in prior year profit.
View our latest analysis for SRF
How Do I Calculate SRF'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 SRF:
P/E of 23.8 = ₹2886.2 ÷ ₹121.26 (Based on the year to June 2019.)
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. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does SRF's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that SRF has a higher P/E than the average (11.7) P/E for companies in the chemicals industry.
Its relatively high P/E ratio indicates that SRF shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
It's nice to see that SRF grew EPS by a stonking 42% in the last year. And its annual EPS growth rate over 5 years is 34%. I'd therefore be a little surprised if its P/E ratio was not relatively high.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.