Despite Its High P/E Ratio, Is Honeywell Automation India Limited (NSE:HONAUT) Still Undervalued?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Honeywell Automation India Limited's (NSE:HONAUT) P/E ratio and reflect on what it tells us about the company's share price. Honeywell Automation India has a P/E ratio of 61.71, based on the last twelve months. In other words, at today's prices, investors are paying ₹61.71 for every ₹1 in prior year profit.

View our latest analysis for Honeywell Automation India

How Do I Calculate Honeywell Automation India's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Honeywell Automation India:

P/E of 61.71 = ₹21617 ÷ ₹350.29 (Based on the trailing twelve months to September 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each ₹1 the company has earned over the last year. 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

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Honeywell Automation 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 Honeywell Automation India's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (21.2) for companies in the electronic industry is lower than Honeywell Automation India's P/E.

Honeywell Automation India's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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 Honeywell Automation India's P/E?

Since Honeywell Automation India holds net cash of ₹11b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Honeywell Automation India's P/E Ratio

Honeywell Automation India trades on a P/E ratio of 61.7, which is multiples above the IN market average of 17.1. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

But note: Honeywell Automation India may not be the best stock to buy. So take a peek at this freelist 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.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.