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A Rising Share Price Has Us Looking Closely At Polycab India Limited's (NSE:POLYCAB) P/E Ratio

Simply Wall St

It's really great to see that even after a strong run, Polycab India (NSE:POLYCAB) shares have been powering on, with a gain of 34% in the last thirty days. Longer term shareholders are no doubt thankful for the recovery in the share price, since it's pretty much flat for the year, even after the recent pop.

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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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 Polycab India

How Does Polycab India's P/E Ratio Compare To Its Peers?

Polycab India's P/E of 19.48 indicates some degree of optimism towards the stock. As you can see below, Polycab India has a higher P/E than the average company (13.0) in the electrical industry.

NSEI:POLYCAB Price Estimation Relative to Market, November 10th 2019

Polycab India's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Polycab India increased earnings per share by a whopping 33% last year. And earnings per share have improved by 31% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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).

How Does Polycab India's Debt Impact Its P/E Ratio?

Polycab India has net cash of ₹4.6b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Polycab India's P/E Ratio

Polycab India has a P/E of 19.5. That's higher than the average in its market, which is 13.3. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings). What we know for sure is that investors have become more excited about Polycab India recently, since they have pushed its P/E ratio from 14.5 to 19.5 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Polycab India. 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 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.