This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Genpact Limited's (NYSE:G), to help you decide if the stock is worth further research. Genpact has a price to earnings ratio of 26.54, based on the last twelve months. In other words, at today's prices, investors are paying $26.54 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Genpact:
P/E of 26.54 = $42.17 ÷ $1.59 (Based on the year to September 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.
Does Genpact Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (30.9) for companies in the it industry is higher than Genpact's P/E.
Its relatively low P/E ratio indicates that Genpact shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Genpact, it's quite possible it could surprise on the upside. You 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that Genpact grew EPS by 13% in the last year. And earnings per share have improved by 13% annually, over the last five years. With that performance, you might expect an above average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Genpact's Debt Impact Its P/E Ratio?
Net debt totals just 9.6% of Genpact's market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On Genpact's P/E Ratio
Genpact's P/E is 26.5 which is above average (18.9) in its market. While the company does use modest debt, its recent earnings growth is very good. So on this analysis it seems reasonable that its P/E ratio is above average.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
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.
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