Is Sudarshan Chemical Industries Limited's (NSE:SUDARSCHEM) High P/E Ratio A Problem For Investors?

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 Sudarshan Chemical Industries Limited's (NSE:SUDARSCHEM) P/E ratio to inform your assessment of the investment opportunity. Sudarshan Chemical Industries has a price to earnings ratio of 23.31, based on the last twelve months. In other words, at today's prices, investors are paying ₹23.31 for every ₹1 in prior year profit.

View our latest analysis for Sudarshan Chemical Industries

How Do You Calculate Sudarshan Chemical Industries's P/E Ratio?

The formula for P/E is:

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

Or for Sudarshan Chemical Industries:

P/E of 23.31 = ₹322.1 ÷ ₹13.82 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. 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.'

Does Sudarshan Chemical Industries Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Sudarshan Chemical Industries has a higher P/E than the average (11.7) P/E for companies in the chemicals industry.

Its relatively high P/E ratio indicates that Sudarshan Chemical Industries 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.

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. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Sudarshan Chemical Industries saw earnings per share improve by -3.3% last year. And its annual EPS growth rate over 5 years is 22%.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

Sudarshan Chemical Industries's Balance Sheet

Sudarshan Chemical Industries has net debt worth 16% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Bottom Line On Sudarshan Chemical Industries's P/E Ratio

Sudarshan Chemical Industries trades on a P/E ratio of 23.3, which is above its market average of 13.3. Given the debt is only modest, and earnings are already moving in the right direction, it's not surprising that the market expects continued improvement.

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

You might be able to find a better buy than Sudarshan Chemical Industries. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.