This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Eimco Elecon (India) Limited’s (NSE:EIMCOELECO) P/E ratio and reflect on what it tells us about the company’s share price. Eimco Elecon (India) has a P/E ratio of 10.47, based on the last twelve months. That corresponds to an earnings yield of approximately 9.5%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Eimco Elecon (India):
P/E of 10.47 = ₹408.95 ÷ ₹39.05 (Based on the year to September 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. 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.’
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Eimco Elecon (India) increased earnings per share by 4.1% last year. And it has bolstered its earnings per share by 5.1% per year over the last five years.
How Does Eimco Elecon (India)’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 (19.9) for companies in the machinery industry is higher than Eimco Elecon (India)’s P/E.
This suggests that market participants think Eimco Elecon (India) will underperform other companies in its industry. Since the market seems unimpressed with Eimco Elecon (India), it’s quite possible it could surprise on the upside. 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
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Eimco Elecon (India)’s Balance Sheet
The extra options and safety that comes with Eimco Elecon (India)’s ₹275m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Eimco Elecon (India)’s P/E Ratio
Eimco Elecon (India) has a P/E of 10.5. That’s below the average in the IN market, which is 16.9. Earnings improved over the last year. And the net cash position gives the company many options. So it’s strange that the low P/E indicates low expectations.
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. Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Eimco Elecon (India). So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.