Is Menon Bearings Limited's (NSE:MENONBE) High P/E Ratio A Problem For Investors?

Simply Wall St

Wed, Jul 17, 2019, 6:50 PM

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Menon Bearings Limited's (NSE:MENONBE) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Menon Bearings's P/E ratio is 15.71. That corresponds to an earnings yield of approximately 6.4%.

View our latest analysis for Menon Bearings

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Menon Bearings:

P/E of 15.71 = ₹70.85 ÷ ₹4.51 (Based on the trailing twelve months to March 2019.)

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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

Does Menon Bearings Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (13.9) for companies in the auto components industry is lower than Menon Bearings's P/E.

NSEI:MENONBE Price Estimation Relative to Market, July 18th 2019

That means that the market expects Menon Bearings will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

It's great to see that Menon Bearings grew EPS by 20% in the last year. And earnings per share have improved by 33% annually, over the last five years. With that performance, you might expect an above average P/E ratio.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.