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A Rising Share Price Has Us Looking Closely At SPL Industries Limited's (NSE:SPLIL) P/E Ratio

Simply Wall St

SPL Industries (NSE:SPLIL) shareholders are no doubt pleased to see that the share price has had a great month, posting a 36% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 11% in the last year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

See our latest analysis for SPL Industries

How Does SPL Industries's P/E Ratio Compare To Its Peers?

SPL Industries's P/E of 4.63 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (10.0) for companies in the luxury industry is higher than SPL Industries's P/E.

NSEI:SPLIL Price Estimation Relative to Market, November 18th 2019

Its relatively low P/E ratio indicates that SPL Industries shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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 unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

In the last year, SPL Industries grew EPS like Taylor Swift grew her fan base back in 2010; the 68% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 64% per year. With that kind of growth rate we would generally expect a high 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. 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.

Is Debt Impacting SPL Industries's P/E?

With net cash of ₹138m, SPL Industries has a very strong balance sheet, which may be important for its business. Having said that, at 11% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On SPL Industries's P/E Ratio

SPL Industries has a P/E of 4.6. That's below the average in the IN market, which is 13.1. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic. What is very clear is that the market has become less pessimistic about SPL Industries over the last month, with the P/E ratio rising from 3.4 back then to 4.6 today. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.

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.

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.