The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how SJVN Limited’s (NSE:SJVN) P/E ratio could help you assess the value on offer. SJVN has a P/E ratio of 9.49, based on the last twelve months. That means that at current prices, buyers pay ₹9.49 for every ₹1 in trailing yearly profits.
How Do You Calculate SJVN’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for SJVN:
P/E of 9.49 = ₹28.1 ÷ ₹2.96 (Based on the year to March 2018.)
Is A High P/E 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
When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
SJVN’s earnings per share fell by 21% in the last twelve months. But EPS is up 5.8% over the last 5 years. And it has shrunk its earnings per share by 8.3% per year over the last three years. This growth rate might warrant a low P/E ratio. This could justify a low P/E.
How Does SJVN’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (10.6) for companies in the electric utilities industry is higher than SJVN’s P/E.
This suggests that market participants think SJVN will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting SJVN’s P/E?
SJVN has net cash of ₹13.2b. 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 SJVN’s P/E Ratio
SJVN’s P/E is 9.5 which is below average (17.6) in the IN market. The recent drop in earnings per share would almost certainly temper expectations, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.
Of course you might be able to find a better stock than SJVN. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org.