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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 Bharat Forge Limited's (NSE:BHARATFORG), to help you decide if the stock is worth further research. Based on the last twelve months, Bharat Forge's P/E ratio is 19.82. That corresponds to an earnings yield of approximately 5.0%.
View our latest analysis for Bharat Forge
How Do You Calculate Bharat Forge's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Bharat Forge:
P/E of 19.82 = ₹439.35 ÷ ₹22.17 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
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. 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.
Bharat Forge increased earnings per share by a whopping 35% last year. And earnings per share have improved by 14% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
How Does Bharat Forge's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Bharat Forge has a higher P/E than the average company (14.9) in the auto components industry.
That means that the market expects Bharat Forge will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.