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 Eris Lifesciences Limited’s (NSE:ERIS) P/E ratio to inform your assessment of the investment opportunity. Eris Lifesciences has a P/E ratio of 31, based on the last twelve months. In other words, at today’s prices, investors are paying ₹31 for every ₹1 in prior year profit.
How Do I Calculate Eris Lifesciences’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Eris Lifesciences:
P/E of 31 = ₹646.6 ÷ ₹20.86 (Based on the trailing twelve months to September 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 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
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.
Eris Lifesciences saw earnings per share improve by -4.9% last year. And its annual EPS growth rate over 5 years is 27%.
How Does Eris Lifesciences’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 (19.2) for companies in the pharmaceuticals industry is lower than Eris Lifesciences’s P/E.
Its relatively high P/E ratio indicates that Eris Lifesciences shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. 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).
Eris Lifesciences’s Balance Sheet
Eris Lifesciences has net debt worth just 2.2% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Bottom Line On Eris Lifesciences’s P/E Ratio
Eris Lifesciences trades on a P/E ratio of 31, which is above the IN market average of 16.6. Given the debt is only modest, and earnings are already moving in the right direction, it’s not surprising that the market expects continued improvement.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
Of course you might be able to find a better stock than Eris Lifesciences. 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 firstname.lastname@example.org.