The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Focus Lighting and Fixtures Limited's (NSE:FOCUS), to help you decide if the stock is worth further research. What is Focus Lighting and Fixtures's P/E ratio? Well, based on the last twelve months it is 5.07. That means that at current prices, buyers pay ₹5.07 for every ₹1 in trailing yearly profits.
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 Focus Lighting and Fixtures:
P/E of 5.07 = ₹49.00 ÷ ₹9.67 (Based on the trailing twelve months to March 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 Focus Lighting and Fixtures Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (13.0) for companies in the electrical industry is higher than Focus Lighting and Fixtures's P/E.
Focus Lighting and Fixtures'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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Focus Lighting and Fixtures's earnings made like a rocket, taking off 61% last year. The sweetener is that the annual five year growth rate of 57% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio. Shareholders have some reason to be optimistic, but the future is always uncertain. So investors 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
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.
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.
Focus Lighting and Fixtures's Balance Sheet
Net debt totals just 4.7% of Focus Lighting and Fixtures's market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On Focus Lighting and Fixtures's P/E Ratio
Focus Lighting and Fixtures has a P/E of 5.1. That's below the average in the IN market, which is 13.4. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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. Thank you for reading.