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 Shakti Pumps (India) Limited’s (NSE:SHAKTIPUMP) P/E ratio could help you assess the value on offer. Shakti Pumps (India) has a price to earnings ratio of 18.04, based on the last twelve months. In other words, at today’s prices, investors are paying ₹18.04 for every ₹1 in prior year profit.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Shakti Pumps (India):
P/E of 18.04 = ₹413.9 ÷ ₹22.95 (Based on the trailing twelve months to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, Shakti Pumps (India) grew EPS by a whopping 92% in the last year. And its annual EPS growth rate over 5 years is 9.7%. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Shakti Pumps (India)’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Shakti Pumps (India) has a lower P/E than the average (19.5) in the machinery industry classification.
Shakti Pumps (India)’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Shakti Pumps (India)’s Debt Impact Its P/E Ratio?
Shakti Pumps (India) has net debt worth 13% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On Shakti Pumps (India)’s P/E Ratio
Shakti Pumps (India) has a P/E of 18. That’s around the same as the average in the IN market, which is 17.1. When you consider the impressive EPS growth last year (along with some debt), it seems the market has questions about whether rapid EPS growth will be sustained.
Investors have an opportunity when market expectations about a stock are wrong. 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.’ 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: Shakti Pumps (India) 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).
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.