This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Pil Italica Lifestyle Limited (NSE:PILITA) is currently trading at a trailing P/E of 19.5x, which is lower than the industry average of 39.7x. While PILITA 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.
What you need to know about 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 PILITA
Price per share = ₹9.11
Earnings per share = ₹0.467
∴ Price-Earnings Ratio = ₹9.11 ÷ ₹0.467 = 19.5x
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 PILITA, 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.
PILITA’s P/E of 19.5x is lower than its industry peers (39.7x), which implies that each dollar of PILITA’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 23 Consumer Durables companies in IN including Jai Mata Glass, Calcom Vision and Jaipan Industries. As such, our analysis shows that PILITA represents an under-priced stock.
A few caveats
However, before you rush out to buy PILITA, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to PILITA. 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 PILITA, then PILITA’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 PILITA, PILITA’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 PILITA to are fairly valued by the market. If this assumption does not hold true, PILITA’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on PILITA, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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:
- Future Outlook: What are well-informed industry analysts predicting for PILITA’s future growth? Take a look at our free research report of analyst consensus for PILITA’s outlook.
- Past Track Record: Has PILITA 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 PILITA’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.