The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Innovative Tyres & Tubes Limited’s (NSE:INNOVATIVE) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Innovative Tyres & Tubes’s P/E ratio is 7.91. That is equivalent to an earnings yield of about 13%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Innovative Tyres & Tubes:
P/E of 7.91 = ₹24 ÷ ₹3.04 (Based on the year to March 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. 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.
Innovative Tyres & Tubes’s earnings per share fell by 40% in the last twelve months. But it has grown its earnings per share by 5.1% per year over the last three years. And it has shrunk its earnings per share by 1.9% per year over the last five years. This might lead to muted expectations.
How Does Innovative Tyres & Tubes’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (17.2) for companies in the auto components industry is higher than Innovative Tyres & Tubes’s P/E.
Innovative Tyres & Tubes’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. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. 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.