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 Cadsys (India) Limited’s (NSE:CADSYS) P/E ratio to inform your assessment of the investment opportunity. Cadsys (India) has a P/E ratio of 4.21, based on the last twelve months. In other words, at today’s prices, investors are paying ₹4.21 for every ₹1 in prior year profit.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Cadsys (India):
P/E of 4.21 = ₹48.8 ÷ ₹11.59 (Based on the year to September 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 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. Earnings growth means that in the future the ‘E’ will be higher. 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.
Cadsys (India)’s earnings per share fell by 27% in the last twelve months. But EPS is up 12% over the last 5 years.
How Does Cadsys (India)’s P/E Ratio Compare To Its Peers?
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 (16.1) for companies in the it industry is higher than Cadsys (India)’s P/E.
This suggests that market participants think Cadsys (India) 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.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. 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).
Cadsys (India)’s Balance Sheet
Cadsys (India) has net cash of ₹40m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Cadsys (India)’s P/E Ratio
Cadsys (India) has a P/E of 4.2. That’s below the average in the IN market, which is 16.2. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.
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, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Cadsys (India) 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 editorial-team@simplywallst.com.