Is Tata Steel Limited's (NSE:TATASTEEL) P/E Ratio Really That Good?

Simply Wall St

Mon, Apr 1, 2019, 6:52 PM

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 Tata Steel Limited's (NSE:TATASTEEL) P/E ratio could help you assess the value on offer. Based on the last twelve months, Tata Steel's P/E ratio is 3.45. That means that at current prices, buyers pay ₹3.45 for every ₹1 in trailing yearly profits.

View our latest analysis for Tata Steel

How Do You Calculate Tata Steel's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Tata Steel:

P/E of 3.45 = ₹534.7 ÷ ₹155.03 (Based on the year 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. 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

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Notably, Tata Steel grew EPS by a whopping 459% in the last year. And it has bolstered its earnings per share by 46% per year over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

How Does Tata Steel's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (11) for companies in the metals and mining industry is higher than Tata Steel's P/E.

NSEI:TATASTEEL Price Estimation Relative to Market, April 2nd 2019

Tata Steel's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Tata Steel, it's quite possible it could surprise on the upside. 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. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.