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 Sterlite Technologies Limited’s (NSE:STRTECH) P/E ratio could help you assess the value on offer. Sterlite Technologies has a P/E ratio of 17.1, based on the last twelve months. In other words, at today’s prices, investors are paying ₹17.1 for every ₹1 in prior year profit.
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How Do I Calculate Sterlite Technologies’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Sterlite Technologies:
P/E of 17.1 = ₹222 ÷ ₹12.98 (Based on the trailing twelve months to December 2018.)
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 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. 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.
Notably, Sterlite Technologies grew EPS by a whopping 81% in the last year. And its annual EPS growth rate over 5 years is 45%. With that performance, I would expect it to have an above average P/E ratio.
How Does Sterlite Technologies’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (15.1) for companies in the communications industry is lower than Sterlite Technologies’s P/E.
That means that the market expects Sterlite Technologies will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).