Does Cholamandalam Investment and Finance Company Limited’s (BOM:511243) PE Ratio Signal A Buying Opportunity?

This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Cholamandalam Investment and Finance Company Limited (BOM:511243)’s fundamentals and stock market performance.

Cholamandalam Investment and Finance Company Limited (BOM:511243) is trading with a trailing P/E of 25.1x, which is lower than the industry average of 26.4x. While this makes 511243 appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View out our latest analysis for Cholamandalam Investment and Finance

Breaking down the P/E ratio

BSE:511243 PE PEG Gauge June 11th 18
BSE:511243 PE PEG Gauge June 11th 18

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.

Formula

Price-Earnings Ratio = Price per share ÷ Earnings per share

P/E Calculation for 511243

Price per share = ₹1568.15

Earnings per share = ₹62.41

∴ Price-Earnings Ratio = ₹1568.15 ÷ ₹62.41 = 25.1x

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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 511243, such as size and country of operation. 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.

Since 511243’s P/E of 25.1x is lower than its industry peers (26.4x), it means that investors are paying less than they should for each dollar of 511243’s earnings. Therefore, according to this analysis, 511243 is an under-priced stock.

Assumptions to watch out for

Before you jump to the conclusion that 511243 represents the perfect buying opportunity, 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 511243. 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 511243, then investors would naturally value 511243 at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with 511243, investors would also value 511243 at a lower price since it is a lower growth investment. Both scenarios would explain why 511243 has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing 511243 to are fairly valued by the market. If this assumption is violated, 511243’s P/E may be lower than its peers because its peers are actually overvalued by investors.

BSE:511243 Future Profit June 11th 18
BSE:511243 Future Profit June 11th 18

What this means for you:

Since you may have already conducted your due diligence on 511243, 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 urge you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for 511243’s future growth? Take a look at our free research report of analyst consensus for 511243’s outlook.
  2. Past Track Record: Has 511243 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 511243’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.