This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
SORIL Infra Resources Limited (NSE:SORILINFRA) is currently trading at a trailing P/E of 64.6x, which is higher than the industry average of 40.5x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. By comparing a stock’s price per share to its earnings per share, we are able to see 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 SORILINFRA
Price per share = ₹396.6
Earnings per share = ₹6.14
∴ Price-Earnings Ratio = ₹396.6 ÷ ₹6.14 = 64.6x
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 SORILINFRA, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use below. 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 64.6x, SORILINFRA’s P/E is higher than its industry peers (40.5x). This implies that investors are overvaluing each dollar of SORILINFRA’s earnings. This multiple is a median of profitable companies of 25 Commercial Services companies in IN including Haria Exports, Omfurn India and Unick Fix-A-Form & Printers. As such, our analysis shows that SORILINFRA represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your SORILINFRA 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 SORILINFRA. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with SORILINFRA, then SORILINFRA’s P/E would naturally be higher since investors would reward SORILINFRA’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with SORILINFRA, SORILINFRA’s P/E would again be higher since investors would reward SORILINFRA’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing SORILINFRA to are fairly valued by the market. If this does not hold, there is a possibility that SORILINFRA’s P/E is higher because firms in our peer group are being undervalued by the market.
What this means for you:
Since you may have already conducted your due diligence on SORILINFRA, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 SORILINFRA’s future growth? Take a look at our free research report of analyst consensus for SORILINFRA’s outlook.
- Past Track Record: Has SORILINFRA 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 SORILINFRA’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.
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 firstname.lastname@example.org.