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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 show how you can use Spectrum Electrical Industries Limited's (NSE:SPECTRUM) P/E ratio to inform your assessment of the investment opportunity. Spectrum Electrical Industries has a P/E ratio of 6.52, based on the last twelve months. In other words, at today's prices, investors are paying ₹6.52 for every ₹1 in prior year profit.
Check out our latest analysis for Spectrum Electrical Industries
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 Spectrum Electrical Industries:
P/E of 6.52 = ₹59 ÷ ₹9.05 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Spectrum Electrical Industries's 71% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 147% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
How Does Spectrum Electrical Industries's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (15.1) for companies in the electrical industry is higher than Spectrum Electrical Industries's P/E.
Its relatively low P/E ratio indicates that Spectrum Electrical Industries 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. You should delve deeper. I like to check if company insiders have been buying or selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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).