Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Jyothy Labs Limited's (NSE:JYOTHYLAB) P/E ratio could help you assess the value on offer. Based on the last twelve months, Jyothy Labs's P/E ratio is 26.92. In other words, at today's prices, investors are paying ₹26.92 for every ₹1 in prior year profit.
How Do You Calculate Jyothy Labs's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Jyothy Labs:
P/E of 26.92 = ₹153.95 ÷ ₹5.72 (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. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does Jyothy Labs Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (26.8) for companies in the household products industry is roughly the same as Jyothy Labs's P/E.
That indicates that the market expects Jyothy Labs will perform roughly in line with other companies in its industry. So if Jyothy Labs actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Jyothy Labs increased earnings per share by 4.7% last year. And earnings per share have improved by 15% annually, over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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 Jyothy Labs's Balance Sheet Tell Us?
Net debt totals just 1.6% of Jyothy Labs's market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On Jyothy Labs's P/E Ratio
Jyothy Labs trades on a P/E ratio of 26.9, which is above its market average of 13.6. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future.
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.
But note: Jyothy Labs may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.