Mohota Industries Limited (NSEI:MOHOTAIND) is trading with a trailing P/E of 83.4x, which is higher than the industry average of 18.2x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Mohota Industries
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 MOHOTAIND
Price per share = ₹180.2
Earnings per share = ₹2.161
∴ Price-Earnings Ratio = ₹180.2 ÷ ₹2.161 = 83.4x
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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to MOHOTAIND, such as capital structure and profitability. 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 83.4x, MOHOTAIND’s P/E is higher than its industry peers (18.2x). This implies that investors are overvaluing each dollar of MOHOTAIND’s earnings. As such, our analysis shows that MOHOTAIND represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your MOHOTAIND shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to MOHOTAIND. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing riskier firms with MOHOTAIND, then MOHOTAIND’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with MOHOTAIND. In this case, MOHOTAIND’s P/E would be higher since investors would also reward MOHOTAIND’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing MOHOTAIND to are fairly valued by the market. If this assumption is violated, MOHOTAIND’s P/E may be higher than its peers because its peers are actually undervalued by investors.
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 MOHOTAIND. 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:
- Financial Health: Is MOHOTAIND’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.
- Past Track Record: Has MOHOTAIND 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 MOHOTAIND’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.