Here's How P/E Ratios Can Help Us Understand Cadsys (India) Limited (NSE:CADSYS)

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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. Looking at earnings over the last twelve months, Cadsys (India) has a P/E ratio of 3.33. That corresponds to an earnings yield of approximately 30%.

Check out our latest analysis for Cadsys (India)

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Cadsys (India):

P/E of 3.33 = ₹55.1 ÷ ₹16.55 (Based on the trailing twelve months to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

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 even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Cadsys (India) increased earnings per share by a whopping 44% last year. And it has bolstered its earnings per share by 25% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

How Does Cadsys (India)'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 Cadsys (India) has a lower P/E than the average (14.1) P/E for companies in the it industry.

This suggests that market participants think Cadsys (India) will underperform other companies in its industry. Since the market seems unimpressed with Cadsys (India), it's quite possible it could surprise on the upside. 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. 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 Cadsys (India)'s P/E?

Cadsys (India) has net cash of ₹124m. This is fairly high at 30% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Cadsys (India)'s P/E Ratio

Cadsys (India)'s P/E is 3.3 which is below average (15.7) in the IN market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. One might conclude that the market is a bit pessimistic, given the low P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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 editorial-team@simplywallst.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.