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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Indian Energy Exchange Limited's (NSE:IEX) P/E ratio to inform your assessment of the investment opportunity. Indian Energy Exchange has a price to earnings ratio of 26.06, based on the last twelve months. That means that at current prices, buyers pay ₹26.06 for every ₹1 in trailing yearly profits.
How Do I Calculate Indian Energy Exchange's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Indian Energy Exchange:
P/E of 26.06 = ₹142.55 ÷ ₹5.47 (Based on the trailing twelve months to March 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. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Indian Energy Exchange Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Indian Energy Exchange has a higher P/E than the average (15.6) P/E for companies in the capital markets industry.
Its relatively high P/E ratio indicates that Indian Energy Exchange shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Most would be impressed by Indian Energy Exchange earnings growth of 23% in the last year. And its annual EPS growth rate over 5 years is 10%. So one might expect 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. Thus, the metric does not reflect cash or debt held by the company. 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.
Indian Energy Exchange's Balance Sheet
Since Indian Energy Exchange holds net cash of ₹3.4b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Indian Energy Exchange's P/E Ratio
Indian Energy Exchange has a P/E of 26.1. That's higher than the average in its market, which is 14.5. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 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.