Does Bharat Petroleum Corporation Limited's (NSE:BPCL) PE Ratio Warrant A Buy?

Bharat Petroleum Corporation Limited (NSEI:BPCL) is currently trading at a trailing P/E of 8.9x, which is lower than the industry average of 13.6x. While BPCL 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 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 Bharat Petroleum

Breaking down the Price-Earnings 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.

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 BPCL, 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 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 8.9x, BPCL’s P/E is lower than its industry peers (13.6x). This implies that investors are undervaluing each dollar of BPCL’s earnings. As such, our analysis shows that BPCL represents an under-priced stock.

Assumptions to watch out for

Before you jump to the conclusion that BPCL 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 BPCL. 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 BPCL, then BPCL’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 BPCL, BPCL’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 BPCL to are fairly valued by the market. If this assumption is violated, BPCL'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 BPCL, 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 BPCL’s future growth? Take a look at our free research report of analyst consensus for BPCL’s outlook.
2. Past Track Record: Has BPCL 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 BPCL'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.