This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Talbros Automotive Components Limited's (NSE:TALBROAUTO) P/E ratio and reflect on what it tells us about the company's share price. Talbros Automotive Components has a P/E ratio of 8.85, based on the last twelve months. In other words, at today's prices, investors are paying ₹8.85 for every ₹1 in prior year profit.

View our latest analysis for Talbros Automotive Components

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Talbros Automotive Components:

P/E of 8.85 = ₹199.45 ÷ ₹22.54 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, Talbros Automotive Components grew EPS by a whopping 29% in the last year. And its annual EPS growth rate over 5 years is 15%. With that performance, I would expect it to have an above average P/E ratio.

How Does Talbros Automotive Components's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Talbros Automotive Components has a lower P/E than the average (15.9) in the auto components industry classification.

Its relatively low P/E ratio indicates that Talbros Automotive Components shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Talbros Automotive Components, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

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

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

Talbros Automotive Components's Balance Sheet

Net debt totals 60% of Talbros Automotive Components's market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Verdict On Talbros Automotive Components's P/E Ratio

Talbros Automotive Components's P/E is 8.9 which is below average (16.2) in the IN market. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Talbros Automotive Components. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.