This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Sonam Clock Limited’s (NSE:SONAMCLOCK), to help you decide if the stock is worth further research. What is Sonam Clock’s P/E ratio? Well, based on the last twelve months it is 10.37. That corresponds to an earnings yield of approximately 9.6%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Sonam Clock:
P/E of 10.37 = INR37.80 ÷ INR3.65 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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’.
Does Sonam Clock 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. We can see in the image below that the average P/E (21.9) for companies in the consumer durables industry is higher than Sonam Clock’s P/E.
This suggests that market participants think Sonam Clock will underperform other companies in its industry. Since the market seems unimpressed with Sonam Clock, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Sonam Clock shrunk earnings per share by 7.3% last year. But over the longer term (5 years) earnings per share have increased by 45%.
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. So it won’t reflect the advantage of cash, or disadvantage of debt. 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.
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).
So What Does Sonam Clock’s Balance Sheet Tell Us?
Sonam Clock has net debt worth 51% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Sonam Clock’s P/E Ratio
Sonam Clock’s P/E is 10.4 which is below average (13.3) in the IN market. When you consider that the company has significant debt, and didn’t grow EPS last year, it isn’t surprising that the market has muted expectations.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Sonam Clock may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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. Thank you for reading.