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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 Ambuja Cements Limited's (NSE:AMBUJACEM) P/E ratio to inform your assessment of the investment opportunity. Ambuja Cements has a price to earnings ratio of 17.17, based on the last twelve months. That means that at current prices, buyers pay ₹17.17 for every ₹1 in trailing yearly profits.
See our latest analysis for Ambuja Cements
How Do You Calculate Ambuja Cements's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ambuja Cements:
P/E of 17.17 = ₹205.8 ÷ ₹11.99 (Based on the year to June 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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Ambuja Cements's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see Ambuja Cements has a lower P/E than the average (19.5) in the basic materials industry classification.
Its relatively low P/E ratio indicates that Ambuja Cements shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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. When earnings grow, the 'E' increases, over time. 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.
Ambuja Cements's 50% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 30% annually, over the last three years. So you might say it really deserves to have an above-average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.