I am writing today to help inform people who are new to the stock market and want to begin learning the link between Lypsa Gems & Jewellery Limited (NSE:LYPSAGEMS)’s fundamentals and stock market performance.
Lypsa Gems & Jewellery Limited (NSE:LYPSAGEMS) is trading with a trailing P/E of 1.5x, which is lower than the industry average of 16x. While this makes LYPSAGEMS appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, 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 Lypsa Gems & Jewellery
Breaking down 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 LYPSAGEMS
Price per share = ₹14.5
Earnings per share = ₹9.52
∴ Price-Earnings Ratio = ₹14.5 ÷ ₹9.52 = 1.5x
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 LYPSAGEMS, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
LYPSAGEMS’s P/E of 1.5x is lower than its industry peers (16x), which implies that each dollar of LYPSAGEMS’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Luxury companies in IN including Nakoda, Nakoda and Gitanjali Gems. As such, our analysis shows that LYPSAGEMS represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy LYPSAGEMS 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 LYPSAGEMS. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with LYPSAGEMS, then LYPSAGEMS’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 LYPSAGEMS, LYPSAGEMS’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 LYPSAGEMS to are fairly valued by the market. If this assumption does not hold true, LYPSAGEMS’s lower P/E ratio may be 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 LYPSAGEMS. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for LYPSAGEMS’s future growth? Take a look at our free research report of analyst consensus for LYPSAGEMS’s outlook.
- Past Track Record: Has LYPSAGEMS 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 LYPSAGEMS’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.