Why Reliance Industries Limited's (NSE:RELIANCE) High P/E Ratio Isn't Necessarily A Bad Thing
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Reliance Industries Limited's (NSE:RELIANCE) P/E ratio to inform your assessment of the investment opportunity. Reliance Industries has a price to earnings ratio of 17.44, based on the last twelve months. That means that at current prices, buyers pay ₹17.44 for every ₹1 in trailing yearly profits.
See our latest analysis for Reliance Industries
How Do You Calculate Reliance Industries's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Reliance Industries:
P/E of 17.44 = ₹1184.35 ÷ ₹67.9 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.'
How Does Reliance Industries's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Reliance Industries has a higher P/E than the average company (9.9) in the oil and gas industry.
That means that the market expects Reliance Industries will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
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. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Most would be impressed by Reliance Industries earnings growth of 10% in the last year. And earnings per share have improved by 11% annually, over the last five years. With that performance, you might expect an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
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).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Reliance Industries's Balance Sheet Tell Us?
Reliance Industries's net debt equates to 30% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On Reliance Industries's P/E Ratio
Reliance Industries's P/E is 17.4 which is above average (13.6) in its market. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. Therefore, it's not particularly surprising that it has a above average P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Reliance Industries. 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.
