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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Ushanti Colour Chem Limited's (NSE:UCL) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Ushanti Colour Chem's P/E ratio is 20.42. That means that at current prices, buyers pay ₹20.42 for every ₹1 in trailing yearly profits.
View our latest analysis for Ushanti Colour Chem
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ushanti Colour Chem:
P/E of 20.42 = ₹62.5 ÷ ₹3.06 (Based on the trailing twelve months 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. 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
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Ushanti Colour Chem saw earnings per share decrease by 33% last year. But over the longer term (3 years), earnings per share have increased by 84%. And EPS is down 5.8% a year, over the last 5 years. This might lead to muted expectations.
How Does Ushanti Colour Chem's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (13.9) for companies in the chemicals industry is lower than Ushanti Colour Chem's P/E.
Ushanti Colour Chem's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. 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
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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.