Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how LT Foods Limited's (NSE:DAAWAT) P/E ratio could help you assess the value on offer. LT Foods has a P/E ratio of 7.29, based on the last twelve months. That is equivalent to an earnings yield of about 14%.
Check out our latest analysis for LT Foods
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 LT Foods:
P/E of 7.29 = ₹28.85 ÷ ₹3.96 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
LT Foods's earnings per share fell by 17% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 5.8%.
How Does LT Foods's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see LT Foods has a lower P/E than the average (17.7) in the food industry classification.
LT Foods's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with LT Foods, 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.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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.
LT Foods's Balance Sheet
Net debt totals a substantial 172% of LT Foods's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On LT Foods's P/E Ratio
LT Foods trades on a P/E ratio of 7.3, which is below the IN market average of 16.2. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations.
Investors should be looking to buy stocks that the market is wrong about. 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.
Of course you might be able to find a better stock than LT Foods. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.