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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how S.P. Apparels Limited's (NSE:SPAL) P/E ratio could help you assess the value on offer. What is S.P. Apparels's P/E ratio? Well, based on the last twelve months it is 9.86. That means that at current prices, buyers pay ₹9.86 for every ₹1 in trailing yearly profits.
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 S.P. Apparels:
P/E of 9.86 = ₹282.6 ÷ ₹28.66 (Based on the year to March 2019.)
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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does S.P. Apparels's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that S.P. Apparels has a lower P/E than the average (10.7) P/E for companies in the luxury industry.
S.P. Apparels's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
In the last year, S.P. Apparels grew EPS like Taylor Swift grew her fan base back in 2010; the 51% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 49% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting S.P. Apparels's P/E?
S.P. Apparels's net debt is 20% of its market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On S.P. Apparels's P/E Ratio
S.P. Apparels's P/E is 9.9 which is below average (15) in the IN market. 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. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.
Investors have an opportunity when market expectations about a stock are wrong. 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 S.P. Apparels. 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 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.