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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Precision Camshafts Limited’s (NSE:PRECAM) P/E ratio could help you assess the value on offer. Based on the last twelve months, Precision Camshafts’s P/E ratio is 11.54. That means that at current prices, buyers pay ₹11.54 for every ₹1 in trailing yearly profits.
See our latest analysis for Precision Camshafts
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Precision Camshafts:
P/E of 11.54 = ₹57.5 ÷ ₹4.98 (Based on the year to March 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Precision Camshafts saw earnings per share decrease by 29% last year. But over the longer term (5 years) earnings per share have increased by 11%. And it has shrunk its earnings per share by 6.0% per year over the last three years. This growth rate might warrant a low P/E ratio. This might lead to low expectations.
How Does Precision Camshafts’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Precision Camshafts has a lower P/E than the average (15.7) P/E for companies in the auto components industry.
This suggests that market participants think Precision Camshafts will underperform other companies in its industry. Since the market seems unimpressed with Precision Camshafts, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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).