Jet Knitwears Limited (NSEI:JETKNIT) is currently trading at a trailing P/E of 70.7x, which is higher than the industry average of 12.5x. While this makes JETKNIT 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Jet Knitwears
Demystifying 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for JETKNIT
Price per share = ₹136.5
Earnings per share = ₹1.93
∴ Price-Earnings Ratio = ₹136.5 ÷ ₹1.93 = 70.7x
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 JETKNIT, 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.
Since JETKNIT’s P/E of 70.7x is higher than its industry peers (12.5x), it means that investors are paying more than they should for each dollar of JETKNIT’s earnings. As such, our analysis shows that JETKNIT represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that JETKNIT should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to JETKNIT. 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 JETKNIT, then investors would naturally value JETKNIT at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with JETKNIT, investors would also value JETKNIT at a higher price since it is a higher growth investment. Both scenarios would explain why JETKNIT has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing JETKNIT to are fairly valued by the market. If this does not hold, there is a possibility that JETKNIT’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 JETKNIT. 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:
1. Financial Health: Is JETKNIT’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 JETKNIT 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 JETKNIT’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.