U.S. Markets close in 23 mins

Should You Be Tempted To Sell Prism Johnson Limited (NSE:PRSMJOHNSN) Because Of Its P/E Ratio?

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Prism Johnson Limited's (NSE:PRSMJOHNSN) P/E ratio and reflect on what it tells us about the company's share price. What is Prism Johnson's P/E ratio? Well, based on the last twelve months it is 40.53. That corresponds to an earnings yield of approximately 2.5%.

Check out our latest analysis for Prism Johnson

How Do You Calculate Prism Johnson's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Prism Johnson:

P/E of 40.53 = ₹83.7 ÷ ₹2.07 (Based on the year to June 2019.)

Is A High Price-to-Earnings 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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

Does Prism Johnson Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Prism Johnson has a higher P/E than the average (19.1) P/E for companies in the basic materials industry.

NSEI:PRSMJOHNSN Price Estimation Relative to Market, August 25th 2019

That means that the market expects Prism Johnson will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Prism Johnson's earnings made like a rocket, taking off 71% last year. Even better, EPS is up 230% per year over three years. So you might say it really deserves to have an above-average P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 Prism Johnson's Debt Impact Its P/E Ratio?

Prism Johnson's net debt equates to 41% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.

The Verdict On Prism Johnson's P/E Ratio

Prism Johnson trades on a P/E ratio of 40.5, which is multiples above its market average of 13. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So on this analysis a high P/E ratio seems reasonable.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.' 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 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.