This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Meghmani Organics Limited’s (NSE:MEGH) P/E ratio could help you assess the value on offer. Meghmani Organics has a price to earnings ratio of 7.12, based on the last twelve months. In other words, at today’s prices, investors are paying ₹7.12 for every ₹1 in prior year profit.
View our latest analysis for Meghmani Organics
How Do I Calculate Meghmani Organics’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Meghmani Organics:
P/E of 7.12 = ₹64 ÷ ₹8.99 (Based on the year to December 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
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. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Meghmani Organics grew EPS by a whopping 42% in the last year. And earnings per share have improved by 40% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Meghmani Organics’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (16.1) for companies in the chemicals industry is higher than Meghmani Organics’s P/E.
Its relatively low P/E ratio indicates that Meghmani Organics 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
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.