Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how Genus Power Infrastructures Limited’s (NSE:GENUSPOWER) P/E ratio could help you assess the value on offer. What is Genus Power Infrastructures’s P/E ratio? Well, based on the last twelve months it is 12.68. That corresponds to an earnings yield of approximately 7.9%.

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View our latest analysis for Genus Power Infrastructures

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Genus Power Infrastructures:

P/E of 12.68 = ₹26.5 ÷ ₹2.09 (Based on the year to March 2019.)

Is A High Price-to-Earnings 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

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Genus Power Infrastructures’s earnings per share fell by 43% in the last twelve months. And EPS is down 8.4% a year, over the last 5 years. This might lead to muted expectations.

How Does Genus Power Infrastructures’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Genus Power Infrastructures has a lower P/E than the average (18.7) in the electronic industry classification.

NSEI:GENUSPOWER Price Estimation Relative to Market, May 16th 2019
NSEI:GENUSPOWER Price Estimation Relative to Market, May 16th 2019

Genus Power Infrastructures’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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).

Is Debt Impacting Genus Power Infrastructures’s P/E?

Genus Power Infrastructures has net debt worth just 9.5% of its market capitalization. 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 Verdict On Genus Power Infrastructures’s P/E Ratio

Genus Power Infrastructures’s P/E is 12.7 which is below average (15.1) in the IN market. With only modest debt, it’s likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. 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.

Of course you might be able to find a better stock than Genus Power Infrastructures. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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