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 Whirlpool of India Limited’s (NSE:WHIRLPOOL) P/E ratio could help you assess the value on offer. Whirlpool of India has a price to earnings ratio of 50.61, based on the last twelve months. In other words, at today’s prices, investors are paying ₹50.61 for every ₹1 in prior year profit.
How Do I Calculate Whirlpool of India’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Whirlpool of India:
P/E of 50.61 = ₹1572.9 ÷ ₹31.08 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each ₹1 the company has earned over the last year. 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
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Most would be impressed by Whirlpool of India earnings growth of 18% in the last year. And its annual EPS growth rate over 5 years is 21%. This could arguably justify a relatively high P/E ratio.
How Does Whirlpool of India’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Whirlpool of India has a higher P/E than the average company (29.1) in the consumer durables industry.
That means that the market expects Whirlpool of India will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. 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
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Is Debt Impacting Whirlpool of India’s P/E?
Whirlpool of India has net cash of ₹9.9b. 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 Whirlpool of India’s P/E Ratio
Whirlpool of India has a P/E of 50.6. That’s significantly higher than the average in the IN market, which is 16.6. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it does not seem strange that the P/E is above average.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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 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. Thank you for reading.