This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Hind Rectifiers Limited's (NSE:HIRECT) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Hind Rectifiers has a P/E ratio of 13.61. In other words, at today's prices, investors are paying ₹13.61 for every ₹1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Hind Rectifiers:
P/E of 13.61 = ₹127.95 ÷ ₹9.4 (Based on the year to June 2019.)
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 Does Hind Rectifiers's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Hind Rectifiers has a higher P/E than the average (12) P/E for companies in the electrical industry.
Its relatively high P/E ratio indicates that Hind Rectifiers shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
In the last year, Hind Rectifiers grew EPS like Taylor Swift grew her fan base back in 2010; the 259% gain was both fast and well deserved. Even better, EPS is up 314% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 Hind Rectifiers's P/E?
Hind Rectifiers's net debt equates to 30% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On Hind Rectifiers's P/E Ratio
Hind Rectifiers has a P/E of 13.6. That's around the same as the average in the IN market, which is 13.6. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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 firstname.lastname@example.org. 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.