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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Sumit Woods Limited’s (NSE:SUMIT) P/E ratio and reflect on what it tells us about the company’s share price. Sumit Woods has a price to earnings ratio of 9.83, based on the last twelve months. In other words, at today’s prices, investors are paying ₹9.83 for every ₹1 in prior year profit.
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 Sumit Woods:
P/E of 9.83 = ₹43.5 ÷ ₹4.43 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Sumit Woods’s earnings per share fell by 38% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 12%.
How Does Sumit Woods’s P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Sumit Woods has a lower P/E than the average (18) P/E for companies in the real estate industry.
This suggests that market participants think Sumit Woods will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won’t reflect the advantage of cash, or disadvantage of debt. 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.
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).
Sumit Woods’s Balance Sheet
Sumit Woods has net debt equal to 46% of its market cap. You’d want to be aware of this fact, but it doesn’t bother us.
The Verdict On Sumit Woods’s P/E Ratio
Sumit Woods has a P/E of 9.8. That’s below the average in the IN market, which is 15.7. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don’t have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Sumit Woods 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.