Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Mazda Limited's (NSE:MAZDALTD) P/E ratio and reflect on what it tells us about the company's share price. Mazda has a P/E ratio of 11.03, based on the last twelve months. That is equivalent to an earnings yield of about 9.1%.
Check out our latest analysis for Mazda
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Mazda:
P/E of 11.03 = ₹365.3 ÷ ₹33.11 (Based on the trailing twelve months 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.
Does Mazda 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 Mazda has a lower P/E than the average (12) P/E for companies in the machinery industry.
This suggests that market participants think Mazda will underperform other companies in its industry. 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.
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 even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Mazda increased earnings per share by a whopping 37% last year. And it has bolstered its earnings per share by 6.6% per year over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting Mazda's P/E?
With net cash of ₹460m, Mazda has a very strong balance sheet, which may be important for its business. Having said that, at 31% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.