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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Shriram Pistons & Rings Limited's (NSE:SHRIPISTON), to help you decide if the stock is worth further research. What is Shriram Pistons & Rings's P/E ratio? Well, based on the last twelve months it is 16.31. That is equivalent to an earnings yield of about 6.1%.
How Do You Calculate Shriram Pistons & Rings's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Shriram Pistons & Rings:
P/E of 16.31 = ₹1009 ÷ ₹61.88 (Based on the year to March 2019.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Shriram Pistons & Rings's earnings per share were pretty steady over the last year. But EPS is up 15% over the last 5 years.
How Does Shriram Pistons & Rings'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 Shriram Pistons & Rings has a higher P/E than the average (14.6) P/E for companies in the auto components industry.
Its relatively high P/E ratio indicates that Shriram Pistons & Rings shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Shriram Pistons & Rings's Balance Sheet
Shriram Pistons & Rings has net cash of ₹535m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Shriram Pistons & Rings's P/E Ratio
Shriram Pistons & Rings trades on a P/E ratio of 16.3, which is above the IN market average of 15.1. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: Shriram Pistons & Rings 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 email@example.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.