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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Pearl Global Industries Limited’s (NSE:PGIL) P/E ratio could help you assess the value on offer. Pearl Global Industries has a price to earnings ratio of 9.31, based on the last twelve months. In other words, at today’s prices, investors are paying ₹9.31 for every ₹1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Pearl Global Industries:
P/E of 9.31 = ₹136.85 ÷ ₹14.71 (Based on the trailing twelve months to September 2018.)
Is A High P/E 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
When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
It’s great to see that Pearl Global Industries grew EPS by 10% in the last year. And it has bolstered its earnings per share by 1.2% per year over the last five years. This could arguably justify a relatively high P/E ratio. Unfortunately, earnings per share are down 9.8% a year, over 3 years.
How Does Pearl Global Industries’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Pearl Global Industries has a lower P/E than the average (11.6) in the luxury industry classification.
Its relatively low P/E ratio indicates that Pearl Global Industries shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Pearl Global Industries, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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).
Pearl Global Industries’s Balance Sheet
Pearl Global Industries’s net debt is 33% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Pearl Global Industries’s P/E Ratio
Pearl Global Industries’s P/E is 9.3 which is below average (16) in the IN market. The company hasn’t stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ We don’t have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Pearl Global Industries 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 firstname.lastname@example.org.