Is Crompton Greaves Consumer Electricals Limited’s (NSE:CROMPTON) High P/E Ratio A Problem For Investors?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Crompton Greaves Consumer Electricals Limited’s (NSE:CROMPTON) P/E ratio to inform your assessment of the investment opportunity. Crompton Greaves Consumer Electricals has a P/E ratio of 38.34, based on the last twelve months. That means that at current prices, buyers pay ₹38.34 for every ₹1 in trailing yearly profits.

View our latest analysis for Crompton Greaves Consumer Electricals

How Do I Calculate Crompton Greaves Consumer Electricals’s Price To Earnings Ratio?

The formula for P/E is:

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

Or for Crompton Greaves Consumer Electricals:

P/E of 38.34 = ₹222.6 ÷ ₹5.81 (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. 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

Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Most would be impressed by Crompton Greaves Consumer Electricals earnings growth of 19% in the last year. And earnings per share have improved by 191% annually, over the last five years. This could arguably justify a relatively high P/E ratio.

How Does Crompton Greaves Consumer Electricals’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 (29.1) for companies in the consumer durables industry is lower than Crompton Greaves Consumer Electricals’s P/E.

NSEI:CROMPTON Price Estimation Relative to Market, March 20th 2019
NSEI:CROMPTON Price Estimation Relative to Market, March 20th 2019

That means that the market expects Crompton Greaves Consumer Electricals will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or 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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

Crompton Greaves Consumer Electricals’s Balance Sheet

Crompton Greaves Consumer Electricals has net cash of ₹1.2b. 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 Crompton Greaves Consumer Electricals’s P/E Ratio

Crompton Greaves Consumer Electricals has a P/E of 38.3. That’s higher than the average in the IN market, which is 16.5. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

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.