In This Article:
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how I G Petrochemicals Limited’s (NSE:IGPL) P/E ratio could help you assess the value on offer. I G Petrochemicals has a P/E ratio of 8.37, based on the last twelve months. That corresponds to an earnings yield of approximately 12%.
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How Do I Calculate I G Petrochemicals’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for I G Petrochemicals:
P/E of 8.37 = ₹396.95 ÷ ₹47.42 (Based on the year to March 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each ₹1 the company has earned over the last year. 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. 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 nice to see that I G Petrochemicals grew EPS by a stonking 44% in the last year. And it has bolstered its earnings per share by 82% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does I G Petrochemicals’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 I G Petrochemicals has a lower P/E than the average (16.3) P/E for companies in the chemicals industry.
I G Petrochemicals’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).