This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use SML Isuzu Limited’s (NSE:SMLISUZU) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, SML Isuzu’s P/E ratio is 52.33. That means that at current prices, buyers pay ₹52.33 for every ₹1 in trailing yearly profits.
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How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for SML Isuzu:
P/E of 52.33 = ₹632.45 ÷ ₹12.08 (Based on the year to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
SML Isuzu increased earnings per share by an impressive 12% over the last twelve months. But earnings per share are down 2.6% per year over the last five years.
How Does SML Isuzu’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (19.3) for companies in the machinery industry is lower than SML Isuzu’s P/E.
SML Isuzu’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting SML Isuzu’s P/E?
SML Isuzu’s net debt is 11% 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 Bottom Line On SML Isuzu’s P/E Ratio
SML Isuzu trades on a P/E ratio of 52.3, which is multiples above the IN market average of 17.1. While the company does use modest debt, its recent earnings growth is impressive. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than SML Isuzu. 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.