Is SREI Infrastructure Finance Limited's (BOM:523756) PE Ratio A Signal To Buy For Investors?

I am writing today to help inform people who are new to the stock market and want to begin learning the link between SREI Infrastructure Finance Limited (BOM:523756)’s fundamentals and stock market performance.

SREI Infrastructure Finance Limited (BOM:523756) is currently trading at a trailing P/E of 10x, which is lower than the industry average of 17x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. 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 SREI Infrastructure Finance

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. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.

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 523756, 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.

523756’s P/E of 10x is lower than its industry peers (17x), which implies that each dollar of 523756’s earnings is being undervalued by investors. Therefore, according to this analysis, 523756 is an under-priced stock.

Assumptions to be aware of

Before you jump to the conclusion that 523756 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 523756. 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 523756, then 523756’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 523756, 523756’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 523756 to are fairly valued by the market. If this assumption is violated, 523756's P/E may be lower than its peers because its peers are actually overvalued by investors.

What this means for you:

Since you may have already conducted your due diligence on 523756, 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 523756’s future growth? Take a look at our free research report of analyst consensus for 523756’s outlook.
2. Past Track Record: Has 523756 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 523756'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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.