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 Kokuyo Camlin Limited's (NSE:KOKUYOCMLN) P/E ratio could help you assess the value on offer. Based on the last twelve months, Kokuyo Camlin's P/E ratio is 49.78. That corresponds to an earnings yield of approximately 2.0%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Kokuyo Camlin:
P/E of 49.78 = ₹75.45 ÷ ₹1.52 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Kokuyo Camlin's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Kokuyo Camlin has a much higher P/E than the average company (13.6) in the commercial services industry.
Kokuyo Camlin's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Kokuyo Camlin's 55% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 43% per year over three years. So we'd absolutely expect it to have a relatively high 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. 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.
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.
So What Does Kokuyo Camlin's Balance Sheet Tell Us?
Kokuyo Camlin's net debt is 20% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On Kokuyo Camlin's P/E Ratio
Kokuyo Camlin trades on a P/E ratio of 49.8, which is multiples above its market average of 13.3. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So to be frank we are not surprised it has a high P/E ratio.
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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.
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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.