Why Sanofi India Limited's (NSE:SANOFI) High P/E Ratio Isn't Necessarily A Bad Thing

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 Sanofi India Limited's (NSE:SANOFI) P/E ratio could help you assess the value on offer. Sanofi India has a P/E ratio of 34.77, based on the last twelve months. In other words, at today's prices, investors are paying ₹34.77 for every ₹1 in prior year profit.

Check out our latest analysis for Sanofi India

How Do You Calculate Sanofi India's P/E Ratio?

The formula for P/E is:

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

Or for Sanofi India:

P/E of 34.77 = ₹5866.00 ÷ ₹168.71 (Based on the trailing twelve months to June 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.

Does Sanofi India Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that Sanofi India has a higher P/E than the average (15.7) P/E for companies in the pharmaceuticals industry.

Its relatively high P/E ratio indicates that Sanofi India 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

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

Sanofi India's earnings per share grew by -3.8% in the last twelve months. And its annual EPS growth rate over 5 years is 8.9%.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Sanofi India's Debt Impact Its P/E Ratio?

Since Sanofi India holds net cash of ₹8.3b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Sanofi India's P/E Ratio

Sanofi India has a P/E of 34.8. That's higher than the average in its market, which is 13.1. Earnings improved over the last year. Also positive, the relatively strong balance sheet will allow for investment in growth -- and the P/E indicates shareholders that will happen!

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