What Does Indiabulls Housing Finance Limited's (NSE:IBULHSGFIN) PE Ratio Tell You?

This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.

Indiabulls Housing Finance Limited (NSE:IBULHSGFIN) is currently trading at a trailing P/E of 12.4x, which is lower than the industry average of 19.7x. While this makes IBULHSGFIN appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Indiabulls Housing Finance

Breaking down the P/E ratio

A common ratio used for relative valuation is the P/E ratio. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.

On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as IBULHSGFIN, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.

Since IBULHSGFIN's P/E of 12.4x is lower than its industry peers (19.7x), it means that investors are paying less than they should for each dollar of IBULHSGFIN's earnings. This multiple is a median of profitable companies of 11 Mortgage companies in IN including GIC Housing Finance, GIC Housing Finance and Indiabulls Housing Finance. Therefore, according to this analysis, IBULHSGFIN is an under-priced stock.

A few caveats

While our conclusion might prompt you to buy IBULHSGFIN immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to IBULHSGFIN. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared higher growth firms with IBULHSGFIN, then IBULHSGFIN’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with IBULHSGFIN, IBULHSGFIN’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing IBULHSGFIN to are fairly valued by the market. If this assumption is violated, IBULHSGFIN's P/E may be lower than its peers because its peers are actually overvalued by investors.

What this means for you:

If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of IBULHSGFIN to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for IBULHSGFIN’s future growth? Take a look at our free research report of analyst consensus for IBULHSGFIN’s outlook.
2. Past Track Record: Has IBULHSGFIN been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of IBULHSGFIN's historicals for more clarity.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.