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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Sree Rayalaseema Hi-Strength Hypo Limited’s (NSE:SRHHYPOLTD) P/E ratio to inform your assessment of the investment opportunity. Sree Rayalaseema Hi-Strength Hypo has a price to earnings ratio of 5.18, based on the last twelve months. That corresponds to an earnings yield of approximately 19%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Sree Rayalaseema Hi-Strength Hypo:
P/E of 5.18 = ₹156.05 ÷ ₹30.1 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Sree Rayalaseema Hi-Strength Hypo’s earnings made like a rocket, taking off 376% last year. The cherry on top is that the five year growth rate was an impressive 78% per year. So I’d be surprised if the P/E ratio was not above average.
Does Sree Rayalaseema Hi-Strength Hypo 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. We can see in the image below that the average P/E (14.8) for companies in the chemicals industry is higher than Sree Rayalaseema Hi-Strength Hypo’s P/E.
This suggests that market participants think Sree Rayalaseema Hi-Strength Hypo will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You 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. 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.
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).
Is Debt Impacting Sree Rayalaseema Hi-Strength Hypo’s P/E?
Net debt totals just 7.0% of Sree Rayalaseema Hi-Strength Hypo’s market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On Sree Rayalaseema Hi-Strength Hypo’s P/E Ratio
Sree Rayalaseema Hi-Strength Hypo’s P/E is 5.2 which is below average (15.3) in the IN market. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified.
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. 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 be able to find a better stock than Sree Rayalaseema Hi-Strength Hypo. 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 firstname.lastname@example.org. 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.