This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Vera Synthetic Limited’s (NSE:VERA) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Vera Synthetic’s P/E ratio is 5.59. That is equivalent to an earnings yield of about 18%.
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How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Vera Synthetic:
P/E of 5.59 = ₹41 ÷ ₹7.34 (Based on the year to September 2018.)
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 isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that Vera Synthetic grew EPS by a stonking 256% in the last year. And it has bolstered its earnings per share by 47% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Vera Synthetic’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Vera Synthetic has a lower P/E than the average (12.5) in the luxury industry classification.
Its relatively low P/E ratio indicates that Vera Synthetic 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. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.