In This Article:
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Navkar Corporation Limited's (NSE:NAVKARCORP) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Navkar has a P/E ratio of 6.43. That means that at current prices, buyers pay ₹6.43 for every ₹1 in trailing yearly profits.
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How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Navkar:
P/E of 6.43 = ₹30 ÷ ₹4.66 (Based on the year to December 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. 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.'
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Navkar's earnings per share fell by 26% in the last twelve months. And it has shrunk its earnings per share by 14% per year over the last five years. This growth rate might warrant a below average P/E ratio.
How Does Navkar's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Navkar has a lower P/E than the average (11.9) P/E for companies in the infrastructure industry.
This suggests that market participants think Navkar will underperform other companies in its 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
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.