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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Ganges Securities Limited's (NSE:GANGESSEC) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Ganges Securities has a P/E ratio of 6.68. In other words, at today's prices, investors are paying ₹6.68 for every ₹1 in prior year profit.

Check out our latest analysis for Ganges Securities

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Ganges Securities:

P/E of 6.68 = ₹46 ÷ ₹6.89 (Based on the year to March 2019.)

Is A High P/E 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 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Ganges Securities's earnings per share fell by 23% in the last twelve months.

Does Ganges Securities 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. If you look at the image below, you can see Ganges Securities has a lower P/E than the average (17.2) in the food industry classification.

Its relatively low P/E ratio indicates that Ganges Securities shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. 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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.

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.

Ganges Securities's Balance Sheet

With net cash of ₹227m, Ganges Securities has a very strong balance sheet, which may be important for its business. Having said that, at 49% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Ganges Securities's P/E Ratio

Ganges Securities trades on a P/E ratio of 6.7, which is below the IN market average of 15.8. The recent drop in earnings per share would almost certainly temper expectations, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation.

Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Ganges Securities 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 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.