Why Gati Limited's (NSE:GATI) High P/E Ratio Isn't Necessarily A Bad Thing

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Gati Limited's (NSE:GATI) P/E ratio could help you assess the value on offer. Based on the last twelve months, Gati's P/E ratio is 38.76. In other words, at today's prices, investors are paying ₹38.76 for every ₹1 in prior year profit.

Check out our latest analysis for Gati

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 Gati:

P/E of 38.76 = ₹65.5 ÷ ₹1.69 (Based on the trailing twelve months to March 2019.)

Is A High P/E 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

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Gati's earnings per share fell by 49% in the last twelve months. And EPS is down 13% a year, over the last 5 years. This could justify a pessimistic P/E.

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

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (22.8) for companies in the logistics industry is lower than Gati's P/E.

That means that the market expects Gati will outperform other companies in its industry. 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

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.

Is Debt Impacting Gati's P/E?

Net debt is 27% of Gati's market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On Gati's P/E Ratio

Gati's P/E is 38.8 which is above average (15.4) in the IN market. With some debt but no EPS growth last year, the market has high expectations of future profits.

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. 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.

You might be able to find a better buy than Gati. 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.