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 Bal Pharma Limited’s (NSE:BALPHARMA) P/E ratio could help you assess the value on offer. Bal Pharma has a price to earnings ratio of 44.14, based on the last twelve months. That is equivalent to an earnings yield of about 2.3%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Bal Pharma:
P/E of 44.14 = ₹86.65 ÷ ₹1.96 (Based on the trailing twelve months to March 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
It’s nice to see that Bal Pharma grew EPS by a stonking 58% in the last year. But earnings per share are down 31% per year over the last five years.
How Does Bal Pharma’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Bal Pharma has a higher P/E than the average (21.5) P/E for companies in the pharmaceuticals industry.
Its relatively high P/E ratio indicates that Bal Pharma shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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).
Bal Pharma’s Balance Sheet
Net debt totals 93% of Bal Pharma’s market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On Bal Pharma’s P/E Ratio
Bal Pharma has a P/E of 44.1. That’s higher than the average in the IN market, which is 17.8. It has already proven it can grow earnings, but the debt levels mean it faces some risks. But if growth falters, the relatively high P/E ratio may prove to be unjustified.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Bal Pharma. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 email@example.com.