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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Lloyds Steels Industries Limited's (NSE:LLOYDSTEEL) P/E ratio could help you assess the value on offer. Lloyds Steels Industries has a price to earnings ratio of 18.33, based on the last twelve months. In other words, at today's prices, investors are paying ₹18.33 for every ₹1 in prior year profit.
See our latest analysis for Lloyds Steels Industries
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Lloyds Steels Industries:
P/E of 18.33 = ₹0.55 ÷ ₹0.030 (Based on the year to March 2019.)
Is A High P/E 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Notably, Lloyds Steels Industries grew EPS by a whopping 30% in the last year. And it has improved its earnings per share by 62% per year over the last three years. So we'd generally expect it to have a relatively high P/E ratio.
How Does Lloyds Steels Industries's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (10) for companies in the metals and mining industry is lower than Lloyds Steels Industries's P/E.
That means that the market expects Lloyds Steels Industries will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
How Does Lloyds Steels Industries's Debt Impact Its P/E Ratio?
With net cash of ₹225m, Lloyds Steels Industries has a very strong balance sheet, which may be important for its business. Having said that, at 46% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Lloyds Steels Industries's P/E Ratio
Lloyds Steels Industries trades on a P/E ratio of 18.3, which is above the IN market average of 15.8. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Lloyds Steels Industries to have a high P/E ratio.
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.' We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Lloyds Steels Industries. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.