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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how FDC Limited's (NSE:FDC) P/E ratio could help you assess the value on offer. Based on the last twelve months, FDC's P/E ratio is 17.98. In other words, at today's prices, investors are paying ₹17.98 for every ₹1 in prior year profit.
See our latest analysis for FDC
How Do You Calculate FDC's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for FDC:
P/E of 17.98 = ₹175.15 ÷ ₹9.74 (Based on the year to March 2019.)
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. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
FDC had pretty flat EPS growth in the last year. But it has grown its earnings per share by 5.1% per year over the last five years.
Does FDC Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below FDC has a P/E ratio that is fairly close for the average for the pharmaceuticals industry, which is 17.3.
Its P/E ratio suggests that FDC shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.