Read This Before You Buy eClerx Services Limited (NSE:ECLERX) Because Of Its P/E Ratio

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 eClerx Services Limited's (NSE:ECLERX) P/E ratio to inform your assessment of the investment opportunity. eClerx Services has a price to earnings ratio of 10.33, based on the last twelve months. In other words, at today's prices, investors are paying ₹10.33 for every ₹1 in prior year profit.

Check out our latest analysis for eClerx Services

How Do You Calculate eClerx Services's P/E Ratio?

The formula for P/E is:

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

Or for eClerx Services:

P/E of 10.33 = ₹502.35 ÷ ₹48.63 (Based on the trailing twelve months to September 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.

Does eClerx Services Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (11.3) for companies in the it industry is higher than eClerx Services's P/E.

eClerx Services's P/E tells us that market participants think it will not fare as well as its peers in the same industry.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

eClerx Services's earnings per share fell by 25% in the last twelve months. And EPS is down 4.2% a year, over the last 5 years. This could justify a pessimistic P/E. If the company can grow EPS strongly, the market may improve its opinion of it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. 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.

eClerx Services's Balance Sheet

With net cash of ₹7.4b, eClerx Services has a very strong balance sheet, which may be important for its business. Having said that, at 40% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On eClerx Services's P/E Ratio

eClerx Services trades on a P/E ratio of 10.3, which is below the IN market average of 13.1. The recent drop in earnings per share would almost certainly temper expectations, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation.

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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

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.

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.

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. Thank you for reading.