The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Sreeleathers Limited’s (NSE:SREEL) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Sreeleathers’s P/E ratio is 14.98. That is equivalent to an earnings yield of about 6.7%.

Check out our latest analysis for Sreeleathers

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Sreeleathers:

P/E of 14.98 = ₹176.25 ÷ ₹11.77 (Based on the trailing twelve months to September 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. 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

Earnings growth rates have a big influence on P/E ratios. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, Sreeleathers grew EPS by a whopping 73% in the last year. And earnings per share have improved by 28% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does Sreeleathers’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (33.3) for companies in the retail distributors industry is higher than Sreeleathers’s P/E.

Sreeleathers’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Is Debt Impacting Sreeleathers’s P/E?

Since Sreeleathers holds net cash of ₹92m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Sreeleathers’s P/E Ratio

Sreeleathers’s P/E is 15 which is below average (16.6) in the IN market. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio.

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 visual report on analyst forecasts could hold they key to an excellent investment decision.

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.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.