This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Pearl Global Industries Limited (NSE:PGIL) is currently trading at a trailing P/E of 11.9, which is lower than the industry average of 14. While PGIL might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
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 PGIL
Price per share = ₹131
Earnings per share = ₹10.991
∴ Price-Earnings Ratio = ₹131 ÷ ₹10.991 = 11.9x
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 PGIL, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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.
PGIL’s P/E of 11.9 is lower than its industry peers (14), which implies that each dollar of PGIL’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 25 Luxury companies in IN including Alka India, Advance Lifestyles and Lypsa Gems & Jewellery. One could put it like this: the market is pricing PGIL as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two important assertions. The first is that our peer group actually contains companies that are similar to PGIL. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with PGIL, then investors would naturally value PGIL at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with PGIL, investors would also value PGIL at a lower price since it is a lower growth investment. Both scenarios would explain why PGIL has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing PGIL to are fairly valued by the market. If this assumption is violated, PGIL’s P/E may be lower than its peers because its peers are actually overvalued 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 add more of PGIL to your portfolio. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for PGIL’s future growth? Take a look at our free research report of analyst consensus for PGIL’s outlook.
- Past Track Record: Has PGIL 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 PGIL’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.