This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Birla Corporation Limited’s (NSE:BIRLACORPN) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Birla has a P/E ratio of 13.2. In other words, at today’s prices, investors are paying ₹13.2 for every ₹1 in prior year profit.
How Do You Calculate Birla’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Birla:
P/E of 13.2 = ₹535.4 ÷ ₹40.57 (Based on the year to June 2019.)
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 Does Birla’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 (19.2) for companies in the basic materials industry is higher than Birla’s P/E.
Birla’s P/E tells us that market participants think it will not fare as well as its peers in the same industry.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Birla’s earnings made like a rocket, taking off 61% last year. The sweetener is that the annual five year growth rate of 19% is also impressive. So I’d be surprised if the P/E ratio was not above average.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Birla’s Balance Sheet
Birla has net debt worth 78% of its market capitalization. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Birla’s P/E Ratio
Birla trades on a P/E ratio of 13.2, which is fairly close to the IN market average of 13.2. The significant levels of debt do detract somewhat from the strong earnings growth. The P/E suggests the market isn’t confident that growth will be sustained, though.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Birla. So you may wish to see this free collection of other companies that have grown earnings strongly.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.