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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Pfizer Limited's (NSE:PFIZER), to help you decide if the stock is worth further research. Pfizer has a P/E ratio of 34.93, based on the last twelve months. That means that at current prices, buyers pay ₹34.93 for every ₹1 in trailing yearly profits.
Check out our latest analysis for Pfizer
How Do I Calculate Pfizer'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 Pfizer:
P/E of 34.93 = ₹3237.7 ÷ ₹92.69 (Based on the year to December 2018.)
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 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
P/E ratios primarily reflect market expectations around earnings growth rates. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Pfizer increased earnings per share by a whopping 31% last year. And it has bolstered its earnings per share by 4.4% per year over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Does Pfizer Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Pfizer has a higher P/E than the average (20.1) P/E for companies in the pharmaceuticals industry.
That means that the market expects Pfizer will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).