The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Gulf Oil Lubricants India Limited’s (NSE:GULFOILLUB) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Gulf Oil Lubricants India’s P/E ratio is 24.54. That is equivalent to an earnings yield of about 4.1%.

Check out our latest analysis for Gulf Oil Lubricants India

How Do You Calculate Gulf Oil Lubricants India’s P/E Ratio?

The formula for P/E is:

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

Or for Gulf Oil Lubricants India:

P/E of 24.54 = ₹810.6 ÷ ₹33.04 (Based on the year to September 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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

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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Most would be impressed by Gulf Oil Lubricants India earnings growth of 20% in the last year. And its annual EPS growth rate over 5 years is 28%. This could arguably justify a relatively high P/E ratio.

How Does Gulf Oil Lubricants India’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Gulf Oil Lubricants India has a higher P/E than the average company (15.6) in the chemicals industry.

Its relatively high P/E ratio indicates that Gulf Oil Lubricants India shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors 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. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Is Debt Impacting Gulf Oil Lubricants India’s P/E?

Since Gulf Oil Lubricants India holds net cash of ₹298m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Gulf Oil Lubricants India’s P/E Ratio

Gulf Oil Lubricants India trades on a P/E ratio of 24.5, which is above the IN market average of 16.5. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. Therefore it seems reasonable that the market would have relatively high expectations of the company

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Gulf Oil Lubricants 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).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.