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 JSW Steel Limited's (NSE:JSWSTEEL) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, JSW Steel's P/E ratio is 8.48. That corresponds to an earnings yield of approximately 12%.
How Do You Calculate JSW Steel's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for JSW Steel:
P/E of 8.48 = ₹222.15 ÷ ₹26.21 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
Does JSW Steel 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 (8.8) for companies in the metals and mining industry is roughly the same as JSW Steel's P/E.
Its P/E ratio suggests that JSW Steel shareholders think that in the future it will perform about the same as other companies in its industry classification.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
JSW Steel shrunk earnings per share by 21% over the last year. But over the longer term (5 years) earnings per share have increased by 34%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
So What Does JSW Steel's Balance Sheet Tell Us?
Net debt totals 73% of JSW Steel's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On JSW Steel's P/E Ratio
JSW Steel's P/E is 8.5 which is below average (13.8) in the IN market. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.
Investors have an opportunity when market expectations about a stock are wrong. 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.
But note: JSW Steel 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).
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.
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