This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Sarveshwar Foods Limited's (NSE:SARVESHWAR) P/E ratio to inform your assessment of the investment opportunity. Sarveshwar Foods has a price to earnings ratio of 4.99, based on the last twelve months. In other words, at today's prices, investors are paying ₹4.99 for every ₹1 in prior year profit.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Sarveshwar Foods:
P/E of 4.99 = ₹39.75 ÷ ₹7.96 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each ₹1 of company 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 Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Sarveshwar Foods maintained roughly steady earnings over the last twelve months. But it has grown its earnings per share by 14% per year over the last five years.
How Does Sarveshwar Foods's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (17.3) for companies in the food industry is higher than Sarveshwar Foods's P/E.
This suggests that market participants think Sarveshwar Foods will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. 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).
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 Sarveshwar Foods's Balance Sheet Tell Us?
Net debt totals a substantial 178% of Sarveshwar Foods's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On Sarveshwar Foods's P/E Ratio
Sarveshwar Foods trades on a P/E ratio of 5, which is below the IN market average of 15.8. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future.
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 you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Sarveshwar Foods. 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 firstname.lastname@example.org. 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.