Should You Be Tempted To Sell Voltamp Transformers Limited (NSE:VOLTAMP) Because Of Its P/E Ratio?

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Voltamp Transformers Limited's (NSE:VOLTAMP), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Voltamp Transformers has a P/E ratio of 14.18. That means that at current prices, buyers pay ₹14.18 for every ₹1 in trailing yearly profits.

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How Do You Calculate Voltamp Transformers's P/E Ratio?

The formula for P/E is:

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

Or for Voltamp Transformers:

P/E of 14.18 = ₹1020.8 ÷ ₹71.96 (Based on the trailing twelve months to December 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Voltamp Transformers shrunk earnings per share by 1.9% last year. But it has grown its earnings per share by 18% per year over the last five years.

How Does Voltamp Transformers's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Voltamp Transformers has a higher P/E than the average company (12.6) in the electrical industry.

Its relatively high P/E ratio indicates that Voltamp Transformers shareholders think it will perform better than other companies in its industry classification. 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

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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).

How Does Voltamp Transformers's Debt Impact Its P/E Ratio?

Voltamp Transformers has net cash of ₹219m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Voltamp Transformers's P/E Ratio

Voltamp Transformers's P/E is 14.2 which is below average (15.4) in the IN market. The recent drop in earnings per share would make investors cautious, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.

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.

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.