Why Oracle Financial Services Software Limited's (NSE:OFSS) High P/E Ratio Isn't Necessarily A Bad Thing

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Oracle Financial Services Software Limited's (NSE:OFSS), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Oracle Financial Services Software has a P/E ratio of 20.69. That corresponds to an earnings yield of approximately 4.8%.

View our latest analysis for Oracle Financial Services Software

How Do I Calculate Oracle Financial Services Software's Price To Earnings Ratio?

The formula for P/E is:

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

Or for Oracle Financial Services Software:

P/E of 20.69 = ₹3351 ÷ ₹161.94 (Based on the year 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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does Oracle Financial Services Software's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Oracle Financial Services Software has a higher P/E than the average company (11.8) in the software industry.

Its relatively high P/E ratio indicates that Oracle Financial Services Software shareholders think it will perform better than other companies in its industry classification.

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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Most would be impressed by Oracle Financial Services Software earnings growth of 12% in the last year. And earnings per share have improved by 9.4% annually, over the last three years. With that performance, you might expect an above average P/E ratio.

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

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Oracle Financial Services Software's Balance Sheet

Oracle Financial Services Software has net cash of ₹27b. 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 Oracle Financial Services Software's P/E Ratio

Oracle Financial Services Software trades on a P/E ratio of 20.7, which is above its market average of 14.3. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it does not seem strange that the P/E is above average.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Oracle Financial Services Software. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.