Should You Be Tempted To Sell Tanla Solutions Limited (NSE:TANLA) Because Of Its P/E Ratio?

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Tanla Solutions Limited's (NSE:TANLA) P/E ratio to inform your assessment of the investment opportunity. Tanla Solutions has a P/E ratio of 16.82, based on the last twelve months. In other words, at today's prices, investors are paying ₹16.82 for every ₹1 in prior year profit.

View our latest analysis for Tanla Solutions

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Tanla Solutions:

P/E of 16.82 = ₹43.4 ÷ ₹2.58 (Based on the trailing twelve months 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 Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

In the last year, Tanla Solutions grew EPS like Taylor Swift grew her fan base back in 2010; the 52% gain was both fast and well deserved. Even better, EPS is up 53% per year over three years. So you might say it really deserves to have an above-average P/E ratio.

How Does Tanla Solutions's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Tanla Solutions has a higher P/E than the average (14.2) P/E for companies in the software industry.

Its relatively high P/E ratio indicates that Tanla Solutions shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

How Does Tanla Solutions's Debt Impact Its P/E Ratio?

With net cash of ₹1.7b, Tanla Solutions has a very strong balance sheet, which may be important for its business. Having said that, at 30% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Tanla Solutions's P/E Ratio

Tanla Solutions trades on a P/E ratio of 16.8, which is above the IN market average of 15.2. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Tanla Solutions to have a high P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Tanla Solutions 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).

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.