This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Mahanagar Gas Limited’s (NSE:MGL) P/E ratio could help you assess the value on offer. Mahanagar Gas has a P/E ratio of 17.56, based on the last twelve months. That means that at current prices, buyers pay ₹17.56 for every ₹1 in trailing yearly profits.
How Do I Calculate Mahanagar Gas’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 Mahanagar Gas:
P/E of 17.56 = ₹920.35 ÷ ₹52.41 (Based on the trailing twelve months to December 2018.)
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. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. 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.
Mahanagar Gas saw earnings per share improve by -9.6% last year. And earnings per share have improved by 11% annually, over the last five years.
How Does Mahanagar Gas’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 Mahanagar Gas has a P/E ratio that is roughly in line with the gas utilities industry average (17.3).
That indicates that the market expects Mahanagar Gas will perform roughly in line with other companies in its industry. So if Mahanagar Gas actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
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. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Mahanagar Gas’s Balance Sheet
Since Mahanagar Gas holds net cash of ₹9.6b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Mahanagar Gas’s P/E Ratio
Mahanagar Gas’s P/E is 17.6 which is above average (15.5) in the IN market. Earnings improved over the last year. Also positive, the relatively strong balance sheet will allow for investment in growth — and the P/E indicates shareholders that will happen!
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Mahanagar Gas. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 email@example.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.