In This Article:
Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Cipla Limited's (NSE:CIPLA) P/E ratio could help you assess the value on offer. Based on the last twelve months, Cipla's P/E ratio is 23.01. That means that at current prices, buyers pay ₹23.01 for every ₹1 in trailing yearly profits.
See our latest analysis for Cipla
How Do I Calculate Cipla's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Cipla:
P/E of 23.01 = ₹444.15 ÷ ₹19.30 (Based on the trailing twelve months to June 2019.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Cipla Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (15.7) for companies in the pharmaceuticals industry is lower than Cipla's P/E.
Its relatively high P/E ratio indicates that Cipla shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.
Cipla's earnings per share grew by -6.9% in the last twelve months. And it has bolstered its earnings per share by 5.3% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Cipla's Balance Sheet
Cipla's net debt is 4.4% of its market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.