This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Reliance Industrial Infrastructure Limited's (NSE:RIIL) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Reliance Industrial Infrastructure's P/E ratio is 49.47. That is equivalent to an earnings yield of about 2.0%.
View our latest analysis for Reliance Industrial Infrastructure
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 Reliance Industrial Infrastructure:
P/E of 49.47 = ₹304.25 ÷ ₹6.15 (Based on the year to September 2019.)
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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does Reliance Industrial Infrastructure Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (10.3) for companies in the oil and gas industry is a lot lower than Reliance Industrial Infrastructure's P/E.
Reliance Industrial Infrastructure's P/E tells us that market participants think the company will perform better than its industry peers, going forward.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. 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.
Reliance Industrial Infrastructure shrunk earnings per share by 8.0% last year. And over the longer term (5 years) earnings per share have decreased 17% annually. So you wouldn't expect a very high P/E. 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.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. 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.
Reliance Industrial Infrastructure's Balance Sheet
The extra options and safety that comes with Reliance Industrial Infrastructure's ₹297m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Reliance Industrial Infrastructure's P/E Ratio
Reliance Industrial Infrastructure's P/E is 49.5 which is way above average (13.2) in its market. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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.