A Sliding Share Price Has Us Looking At Cholamandalam Investment and Finance Company Limited’s (NSE:CHOLAFIN) P/E Ratio

Unfortunately for some shareholders, the Cholamandalam Investment and Finance (NSE:CHOLAFIN) share price has dived 31% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 18% over that longer period.

All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors’ expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

See our latest analysis for Cholamandalam Investment and Finance

How Does Cholamandalam Investment and Finance’s P/E Ratio Compare To Its Peers?

Cholamandalam Investment and Finance’s P/E of 13.65 indicates some degree of optimism towards the stock. The image below shows that Cholamandalam Investment and Finance has a higher P/E than the average (12.5) P/E for companies in the consumer finance industry.

NSEI:CHOLAFIN Price Estimation Relative to Market, March 17th 2020
NSEI:CHOLAFIN Price Estimation Relative to Market, March 17th 2020

Its relatively high P/E ratio indicates that Cholamandalam Investment and Finance 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

Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Most would be impressed by Cholamandalam Investment and Finance earnings growth of 16% in the last year. And its annual EPS growth rate over 5 years is 25%. So one might expect an above average P/E ratio.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

So What Does Cholamandalam Investment and Finance’s Balance Sheet Tell Us?

Net debt totals a substantial 257% of Cholamandalam Investment and Finance’s market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.

The Bottom Line On Cholamandalam Investment and Finance’s P/E Ratio

Cholamandalam Investment and Finance has a P/E of 13.6. That’s higher than the average in its market, which is 10.8. It has already proven it can grow earnings, but the debt levels mean it faces some risks. The relatively high P/E ratio suggests shareholders think growth will continue. Given Cholamandalam Investment and Finance’s P/E ratio has declined from 19.9 to 13.6 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who don’t like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Cholamandalam Investment and Finance. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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