Does Aarti Drugs Limited (NSE:AARTIDRUGS) Have A Good P/E Ratio?

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Aarti Drugs Limited's (NSE:AARTIDRUGS), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Aarti Drugs has a P/E ratio of 15.03. That is equivalent to an earnings yield of about 6.7%.

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How Do I Calculate Aarti Drugs'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 Aarti Drugs:

P/E of 15.03 = ₹554.9 ÷ ₹36.92 (Based on the trailing twelve months to December 2018.)

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. 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.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

It's great to see that Aarti Drugs grew EPS by 12% in the last year. And its annual EPS growth rate over 5 years is 11%. So one might expect an above average P/E ratio.

How Does Aarti Drugs's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Aarti Drugs has a lower P/E than the average (18) in the pharmaceuticals industry classification.

Aarti Drugs's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Aarti Drugs, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

Is Debt Impacting Aarti Drugs's P/E?

Aarti Drugs has net debt equal to 38% of its market cap. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Aarti Drugs's P/E Ratio

Aarti Drugs's P/E is 15 which is about average (15.4) in the IN market. Given it has reasonable debt levels, and grew earnings strongly last year, the P/E indicates the market has doubts this growth can be sustained. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.

Investors should be looking to buy stocks that the market is wrong about. 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.