Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Orbit Exports Limited's (NSE:ORBTEXP) P/E ratio could help you assess the value on offer. Orbit Exports has a price to earnings ratio of 10.33, based on the last twelve months. That is equivalent to an earnings yield of about 9.7%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Orbit Exports:
P/E of 10.33 = ₹91.45 ÷ ₹8.85 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings 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.
Does Orbit Exports Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below Orbit Exports has a P/E ratio that is fairly close for the average for the luxury industry, which is 10.2.
Orbit Exports's P/E tells us that market participants think its prospects are roughly in line with its industry.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.
Orbit Exports saw earnings per share decrease by 5.3% last year. But EPS is up 3.1% over the last 5 years. The company could impress by growing EPS, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Orbit Exports's Balance Sheet
Orbit Exports has net cash of ₹202m. 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 Orbit Exports's P/E Ratio
Orbit Exports has a P/E of 10.3. That's below the average in the IN market, which is 13.3. Falling earnings per share are likely to be keeping potential buyers away, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Orbit Exports 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 firstname.lastname@example.org. 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.