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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 Eris Lifesciences Limited's (NSE:ERIS), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Eris Lifesciences has a P/E ratio of 19.41. In other words, at today's prices, investors are paying ₹19.41 for every ₹1 in prior year profit.
View our latest analysis for Eris Lifesciences
How Do I Calculate Eris Lifesciences's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Eris Lifesciences:
P/E of 19.41 = ₹428.55 ÷ ₹22.08 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Does Eris Lifesciences's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Eris Lifesciences has a higher P/E than the average (16.1) P/E for companies in the pharmaceuticals industry.
That means that the market expects Eris Lifesciences will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. 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.
Eris Lifesciences saw earnings per share improve by -3.1% last year. And its annual EPS growth rate over 5 years is 34%.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).