Does Varroc Engineering Limited (NSE:VARROC) Have A Good P/E Ratio?

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Varroc Engineering Limited's (NSE:VARROC) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Varroc Engineering has a P/E ratio of 13.84. That corresponds to an earnings yield of approximately 7.2%.

Check out our latest analysis for Varroc Engineering

How Do You Calculate Varroc Engineering's P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Varroc Engineering:

P/E of 13.84 = ₹458.15 ÷ ₹33.11 (Based on the year to March 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 Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Varroc Engineering had pretty flat EPS growth in the last year. But it has grown its earnings per share by 52% per year over the last five years. And EPS is down 4.8% a year, over the last 3 years. So it would be surprising to see a high P/E.

How Does Varroc Engineering's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Varroc Engineering has a lower P/E than the average (15.7) P/E for companies in the auto components industry.

Varroc Engineering's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

Is Debt Impacting Varroc Engineering's P/E?

Varroc Engineering's net debt is 23% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Varroc Engineering's P/E Ratio

Varroc Engineering's P/E is 13.8 which is below average (16.2) in the IN market. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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.

But note: Varroc Engineering 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).

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 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. Thank you for reading.