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A Rising Share Price Has Us Looking Closely At SORIL Infra Resources Limited's (NSE:SORILINFRA) P/E Ratio

Simply Wall St

SORIL Infra Resources (NSE:SORILINFRA) shares have had a really impressive month, gaining 32%, after some slippage. However, that doesn't change the fact that longer term shareholders might have been mercilessly wrecked by the 70% share price decline throughout the year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

View our latest analysis for SORIL Infra Resources

How Does SORIL Infra Resources's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 28.14 that there is some investor optimism about SORIL Infra Resources. The image below shows that SORIL Infra Resources has a higher P/E than the average (12.8) P/E for companies in the commercial services industry.

NSEI:SORILINFRA Price Estimation Relative to Market, November 11th 2019

That means that the market expects SORIL Infra Resources will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

SORIL Infra Resources saw earnings per share decrease by 25% last year. And over the longer term (5 years) earnings per share have decreased 22% annually. This growth rate might warrant a below average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

So What Does SORIL Infra Resources's Balance Sheet Tell Us?

SORIL Infra Resources's net debt is 60% of its market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Verdict On SORIL Infra Resources's P/E Ratio

SORIL Infra Resources trades on a P/E ratio of 28.1, which is above its market average of 13.3. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth in the future. What we know for sure is that investors have become much more excited about SORIL Infra Resources recently, since they have pushed its P/E ratio from 21.3 to 28.1 over the last month. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than SORIL Infra Resources. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 editorial-team@simplywallst.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.