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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Rama Steel Tubes Limited's (NSE:RAMASTEEL) P/E ratio to inform your assessment of the investment opportunity. Rama Steel Tubes has a price to earnings ratio of 15.92, based on the last twelve months. That is equivalent to an earnings yield of about 6.3%.
View our latest analysis for Rama Steel Tubes
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 Rama Steel Tubes:
P/E of 15.92 = ₹100.4 ÷ ₹6.31 (Based on the year to December 2018.)
Is A High P/E 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
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Rama Steel Tubes had pretty flat EPS growth in the last year. But it has grown its earnings per share by 16% per year over the last three years. And EPS is down 2.3% a year, over the last 5 years. So you wouldn't expect a very high P/E.
Does Rama Steel Tubes Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Rama Steel Tubes has a higher P/E than the average company (11.2) in the metals and mining industry.
That means that the market expects Rama Steel Tubes will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. 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.