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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Pennar Industries Limited’s (NSE:PENIND) P/E ratio to inform your assessment of the investment opportunity. Pennar Industries has a price to earnings ratio of 4.82, based on the last twelve months. That is equivalent to an earnings yield of about 21%.
View our latest analysis for Pennar Industries
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 Pennar Industries:
P/E of 4.82 = ₹31.9 ÷ ₹6.62 (Based on the trailing twelve months to December 2018.)
Is A High P/E 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
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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s nice to see that Pennar Industries grew EPS by a stonking 48% in the last year. And earnings per share have improved by 24% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Pennar Industries’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Pennar Industries has a lower P/E than the average (10.3) in the metals and mining industry classification.
Its relatively low P/E ratio indicates that Pennar Industries 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. 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).