Read This Before You Buy Kothari Petrochemicals Limited (NSE:KOTHARIPET) Because Of Its P/E Ratio

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Kothari Petrochemicals Limited's (NSE:KOTHARIPET) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Kothari Petrochemicals has a P/E ratio of 8.65. That is equivalent to an earnings yield of about 12%.

Check out our latest analysis for Kothari Petrochemicals

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 Kothari Petrochemicals:

P/E of 8.65 = ₹17.9 ÷ ₹2.07 (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 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Kothari Petrochemicals increased earnings per share by a whopping 27% last year. And earnings per share have improved by 9.0% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

How Does Kothari Petrochemicals's P/E Ratio Compare To Its Peers?

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 Kothari Petrochemicals has a lower P/E than the average (14) in the chemicals industry classification.

Kothari 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. You should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.

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.

How Does Kothari Petrochemicals's Debt Impact Its P/E Ratio?

Kothari Petrochemicals has net debt worth 14% of its market capitalization. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.

The Bottom Line On Kothari Petrochemicals's P/E Ratio

Kothari Petrochemicals's P/E is 8.6 which is below average (16) in the IN market. The company hasn't stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.

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.' We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Kothari Petrochemicals. 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.