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 CIL Nova Petrochemicals Limited’s (NSE:CNOVAPETRO) P/E ratio could help you assess the value on offer. CIL Nova Petrochemicals has a P/E ratio of 66.64, based on the last twelve months. In other words, at today’s prices, investors are paying ₹66.64 for every ₹1 in prior year profit.
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 CIL Nova Petrochemicals:
P/E of 66.64 = ₹25.7 ÷ ₹0.39 (Based on the trailing twelve months to September 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. 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
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. 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.
CIL Nova Petrochemicals saw earnings per share decrease by 8.7% last year. And over the longer term (5 years) earnings per share have decreased 12% annually. So we might expect a relatively low P/E.
How Does CIL Nova Petrochemicals’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 (13.1) for companies in the luxury industry is a lot lower than CIL Nova Petrochemicals’s P/E.
That means that the market expects CIL Nova Petrochemicals will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
CIL Nova Petrochemicals’s Balance Sheet
CIL Nova Petrochemicals has net debt worth 31% of its market capitalization. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Verdict On CIL Nova Petrochemicals’s P/E Ratio
CIL Nova Petrochemicals has a P/E of 66.6. That’s significantly higher than the average in the IN market, which is 17. 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. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. We don’t have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: CIL Nova Petrochemicals 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).
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.