Why L&T Technology Services Limited's (NSE:LTTS) High P/E Ratio Isn't Necessarily A Bad Thing

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how L&T Technology Services Limited's (NSE:LTTS) P/E ratio could help you assess the value on offer. L&T Technology Services has a P/E ratio of 21.27, based on the last twelve months. In other words, at today's prices, investors are paying ₹21.27 for every ₹1 in prior year profit.

See our latest analysis for L&T Technology Services

How Do You Calculate L&T Technology Services's P/E Ratio?

The formula for price to earnings is:

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

Or for L&T Technology Services:

P/E of 21.27 = ₹1582.5 ÷ ₹74.39 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each ₹1 the company has earned over the last year. 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 L&T Technology Services 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. As you can see below L&T Technology Services has a P/E ratio that is fairly close for the average for the professional services industry, which is 20.8.

Its P/E ratio suggests that L&T Technology Services shareholders think that in the future it will perform about the same as other companies in its industry classification.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.

L&T Technology Services increased earnings per share by a whopping 26% last year. And it has bolstered its earnings per share by 145% per year over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

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. Thus, the metric does not reflect cash or debt held by the company. 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).

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 L&T Technology Services's P/E?

Since L&T Technology Services holds net cash of ₹9.4b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On L&T Technology Services's P/E Ratio

L&T Technology Services has a P/E of 21.3. That's higher than the average in its market, which is 13.7. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. Therefore it seems reasonable that the market would have relatively high expectations of the company

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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: L&T Technology Services 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).

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.