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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how PC Jeweller Limited’s (NSE:PCJEWELLER) P/E ratio could help you assess the value on offer. PC Jeweller has a price to earnings ratio of 5.45, based on the last twelve months. In other words, at today’s prices, investors are paying ₹5.45 for every ₹1 in prior year profit.
How Do You Calculate PC Jeweller’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for PC Jeweller:
P/E of 5.45 = ₹76.85 ÷ ₹14.09 (Based on the trailing twelve months to March 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. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Most would be impressed by PC Jeweller earnings growth of 20% in the last year. And its annual EPS growth rate over 5 years is 6.8%. So one might expect an above average P/E ratio.
How Does PC Jeweller’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (20.9) for companies in the specialty retail industry is higher than PC Jeweller’s P/E.
Its relatively low P/E ratio indicates that PC Jeweller shareholders think it will struggle to do as well as other companies in its industry classification. 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.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting PC Jeweller’s P/E?
PC Jeweller has net debt worth 23% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On PC Jeweller’s P/E Ratio
PC Jeweller trades on a P/E ratio of 5.5, which is below the IN market average of 15.9. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors have an opportunity when market expectations about a stock are wrong. 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: PC Jeweller 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).
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.