In This Article:
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 Firstsource Solutions Limited’s (NSE:FSL) P/E ratio could help you assess the value on offer. Firstsource Solutions has a price to earnings ratio of 8.93, based on the last twelve months. That corresponds to an earnings yield of approximately 11%.
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How Do You Calculate Firstsource Solutions’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Firstsource Solutions:
P/E of 8.93 = ₹48.55 ÷ ₹5.43 (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. 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.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It’s nice to see that Firstsource Solutions grew EPS by a stonking 37% in the last year. And earnings per share have improved by 12% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Firstsource Solutions’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Firstsource Solutions has a lower P/E than the average (16.4) P/E for companies in the it industry.
Its relatively low P/E ratio indicates that Firstsource Solutions shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.