The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Century Enka Limited's (NSE:CENTENKA) P/E ratio to inform your assessment of the investment opportunity. Century Enka has a price to earnings ratio of 4.11, based on the last twelve months. That is equivalent to an earnings yield of about 24.4%.
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 Century Enka:
P/E of 4.11 = ₹179.20 ÷ ₹43.65 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.
Does Century Enka Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (10.4) for companies in the luxury industry is higher than Century Enka's P/E.
This suggests that market participants think Century Enka will underperform other companies in its industry. Since the market seems unimpressed with Century Enka, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Century Enka increased earnings per share by 4.2% last year. And its annual EPS growth rate over 5 years is 15%.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
How Does Century Enka's Debt Impact Its P/E Ratio?
With net cash of ₹1.9b, Century Enka has a very strong balance sheet, which may be important for its business. Having said that, at 48% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Century Enka's P/E Ratio
Century Enka's P/E is 4.1 which is below average (13.3) in the IN market. EPS was up modestly better over the last twelve months. And the net cash position gives the company many options. So it's strange that the low P/E indicates low expectations.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Century Enka 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).
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.
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. Thank you for reading.
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