I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Future Enterprises Limited (NSE:FELDVR) is currently trading at a trailing P/E of 51.9x, which is higher than the industry average of 31.3x. While this makes FELDVR appear like a stock to avoid or sell if you own it, 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 Future Enterprises
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for FELDVR
Price per share = ₹38.5
Earnings per share = ₹0.742
∴ Price-Earnings Ratio = ₹38.5 ÷ ₹0.742 = 51.9x
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. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to FELDVR, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will 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.
At 51.9x, FELDVR’s P/E is higher than its industry peers (31.3x). This implies that investors are overvaluing each dollar of FELDVR’s earnings. This multiple is a median of profitable companies of 16 Industrials companies in IN including Nava Bharat Ventures, Nava Bharat Ventures and Balmer Lawrie. As such, our analysis shows that FELDVR represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your FELDVR shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to FELDVR. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with FELDVR, then investors would naturally value FELDVR at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with FELDVR, investors would also value FELDVR at a higher price since it is a higher growth investment. Both scenarios would explain why FELDVR has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing FELDVR to are fairly valued by the market. If this does not hold, there is a possibility that FELDVR’s P/E is higher because firms in our peer group are being undervalued by the market.
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 rebalance your portfolio and reduce your holdings in FELDVR. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for FELDVR’s future growth? Take a look at our free research report of analyst consensus for FELDVR’s outlook.
- Past Track Record: Has FELDVR 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 FELDVR’s historicals for more clarity.
- 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.