Here’s How P/E Ratios Can Help Us Understand I G Petrochemicals Limited (NSE:IGPL)

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how I G Petrochemicals Limited’s (NSE:IGPL) P/E ratio could help you assess the value on offer. I G Petrochemicals has a P/E ratio of 8.37, based on the last twelve months. That corresponds to an earnings yield of approximately 12%.

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How Do I Calculate I G Petrochemicals’s Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for I G Petrochemicals:

P/E of 8.37 = ₹396.95 ÷ ₹47.42 (Based on the year to March 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

P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

It’s nice to see that I G Petrochemicals grew EPS by a stonking 44% in the last year. And it has bolstered its earnings per share by 82% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does I G Petrochemicals’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that I G Petrochemicals has a lower P/E than the average (16.3) P/E for companies in the chemicals industry.

I G Petrochemicals’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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

The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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.

Is Debt Impacting I G Petrochemicals’s P/E?

Net debt totals just 3.6% of I G Petrochemicals’s market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On I G Petrochemicals’s P/E Ratio

I G Petrochemicals trades on a P/E ratio of 8.4, which is below the IN market average of 17.1. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified.

Investors have an opportunity when market expectations about a stock are wrong. 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.

But note: I G Petrochemicals 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).

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.