This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at SORIL Infra Resources Limited’s (NSE:SORILINFRA) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, SORIL Infra Resources’s P/E ratio is 41.27. That is equivalent to an earnings yield of about 2.4%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for SORIL Infra Resources:
P/E of 41.27 = ₹253.3 ÷ ₹6.14 (Based on the trailing twelve months to March 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
SORIL Infra Resources’s earnings per share fell by 47% in the last twelve months. But over the longer term (3 years), earnings per share have increased by 4.4%. And over the longer term (5 years) earnings per share have decreased 17% annually. This could justify a pessimistic P/E.
How Does SORIL Infra Resources’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 (13.4) for companies in the commercial services industry is a lot lower than SORIL Infra Resources’s P/E.
That means that the market expects SORIL Infra Resources will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 SORIL Infra Resources’s Debt Impact Its P/E Ratio?
SORIL Infra Resources has net debt worth 40% of its market capitalization. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On SORIL Infra Resources’s P/E Ratio
SORIL Infra Resources has a P/E of 41.3. That’s higher than the average in the IN market, which is 15.6. With a bit of debt, but a lack of recent growth, it’s safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
You might be able to find a better buy than SORIL Infra Resources. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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.