Should You Buy Zenith Fibres Limited (BOM:514266) At This PE Ratio?

This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Zenith Fibres Limited (BOM:514266)’s fundamentals and stock market performance.

Zenith Fibres Limited (BOM:514266) is trading with a trailing P/E of 11.1x, which is lower than the industry average of 16.9x. While this makes 514266 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 Zenith Fibres

Breaking down the Price-Earnings 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.

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 514266, 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.

At 11.1x, 514266’s P/E is lower than its industry peers (16.9x). This implies that investors are undervaluing each dollar of 514266’s earnings. Therefore, according to this analysis, 514266 is an under-priced stock.

Assumptions to watch out for

However, before you rush out to buy 514266, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to 514266. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with 514266, then investors would naturally value 514266 at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with 514266, investors would also value 514266 at a lower price since it is a lower growth investment. Both scenarios would explain why 514266 has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing 514266 to are fairly valued by the market. If this does not hold, there is a possibility that 514266’s P/E is lower because firms in our peer group are being overvalued by the market.

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to 514266. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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:

1. Financial Health: Is 514266’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
2. Past Track Record: Has 514266 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 514266'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.