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 Sri Krishna Metcom Limited’s (NSE:SKML) P/E ratio to inform your assessment of the investment opportunity. Sri Krishna Metcom has a P/E ratio of 20.57, based on the last twelve months. That means that at current prices, buyers pay ₹20.57 for every ₹1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Sri Krishna Metcom:
P/E of 20.57 = ₹65 ÷ ₹3.16 (Based on the trailing twelve months to March 2018.)
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.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Sri Krishna Metcom increased earnings per share by a whopping 240% last year. And earnings per share have improved by 55% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Sri Krishna Metcom’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (20.3) for companies in the food industry is roughly the same as Sri Krishna Metcom’s P/E.
Sri Krishna Metcom’s P/E tells us that market participants think its prospects are roughly in line with its industry. So if Sri Krishna Metcom actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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).
Sri Krishna Metcom’s Balance Sheet
Sri Krishna Metcom has net debt worth 25% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Sri Krishna Metcom’s P/E Ratio
Sri Krishna Metcom’s P/E is 20.6 which is above average (17.6) in the IN market. Its debt levels do not imperil its balance sheet and it has already proven it can grow. Therefore it seems reasonable that the market would have relatively high expectations of the company
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.’ Although we don’t have analyst forecasts, you might want to assess this data-rich visualization 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.
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.