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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 West Coast Paper Mills Limited's (NSE:WSTCSTPAPR) P/E ratio could help you assess the value on offer. Based on the last twelve months, West Coast Paper Mills's P/E ratio is 5.34. That corresponds to an earnings yield of approximately 19%.
How Do I Calculate West Coast Paper Mills's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for West Coast Paper Mills:
P/E of 5.34 = ₹239.25 ÷ ₹44.82 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
West Coast Paper Mills increased earnings per share by a whopping 33% last year. And its annual EPS growth rate over 5 years is 114%. With that performance, I would expect it to have an above average P/E ratio.
How Does West Coast Paper Mills's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (8.9) for companies in the forestry industry is higher than West Coast Paper Mills's P/E.
This suggests that market participants think West Coast Paper Mills will underperform other companies in its industry. Since the market seems unimpressed with West Coast Paper Mills, 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.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. 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 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.
West Coast Paper Mills's Balance Sheet
West Coast Paper Mills's net debt is 5.0% of its 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 West Coast Paper Mills's P/E Ratio
West Coast Paper Mills trades on a P/E ratio of 5.3, which is below the IN market average of 15.8. The company hasn't stretched its balance sheet, and earnings growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 West Coast Paper Mills. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.