Why Johnson Controls-Hitachi Air Conditioning India Limited's (NSE:JCHAC) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

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 Johnson Controls-Hitachi Air Conditioning India Limited's (NSE:JCHAC) P/E ratio could help you assess the value on offer. Based on the last twelve months, Johnson Controls-Hitachi Air Conditioning India's P/E ratio is 53.43. That is equivalent to an earnings yield of about 1.9%.

View our latest analysis for Johnson Controls-Hitachi Air Conditioning India

How Do I Calculate Johnson Controls-Hitachi Air Conditioning India's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Johnson Controls-Hitachi Air Conditioning India:

P/E of 53.43 = ₹1940.55 ÷ ₹36.32 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Johnson Controls-Hitachi Air Conditioning India Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. As you can see below, Johnson Controls-Hitachi Air Conditioning India has a higher P/E than the average company (22.5) in the consumer durables industry.

NSEI:JCHAC Price Estimation Relative to Market, October 12th 2019

That means that the market expects Johnson Controls-Hitachi Air Conditioning India 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.

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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Most would be impressed by Johnson Controls-Hitachi Air Conditioning India earnings growth of 11% in the last year. And its annual EPS growth rate over 5 years is 22%. This could arguably justify a relatively high P/E ratio.

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. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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 Johnson Controls-Hitachi Air Conditioning India's Debt Impact Its P/E Ratio?

Net debt totals just 3.0% of Johnson Controls-Hitachi Air Conditioning India's market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On Johnson Controls-Hitachi Air Conditioning India's P/E Ratio

Johnson Controls-Hitachi Air Conditioning India's P/E is 53.4 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. Therefore, it's not particularly surprising that it has a above average P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Johnson Controls-Hitachi Air Conditioning India 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).

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.