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 Public Joint Stock Company Kostroma Power Sale Company's (MCX:KTSB) P/E ratio could help you assess the value on offer. Kostroma Power Sale has a P/E ratio of 13.75, based on the last twelve months. In other words, at today's prices, investors are paying RUB13.75 for every RUB1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Kostroma Power Sale:
P/E of 13.75 = RUB0.58 ÷ RUB0.04 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each RUB1 of company earnings. 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 Kostroma Power Sale's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Kostroma Power Sale has a higher P/E than the average (7.6) P/E for companies in the electric utilities industry.
Kostroma Power Sale's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. 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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Most would be impressed by Kostroma Power Sale earnings growth of 13% in the last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
How Does Kostroma Power Sale's Debt Impact Its P/E Ratio?
Kostroma Power Sale's net debt is considerable, at 114% of its market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Bottom Line On Kostroma Power Sale's P/E Ratio
Kostroma Power Sale has a P/E of 13.8. That's higher than the average in its market, which is 8.2. While the meaningful level of debt does limit its options, it has achieved solid growth over the last year. It seems the market believes growth will continue, judging by the P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. 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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Kostroma Power Sale. 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).
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.
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