Is It Time To Buy Ravi Kumar Distilleries Limited (NSE:RKDL) Based Off Its PE Ratio?

Ravi Kumar Distilleries Limited (NSEI:RKDL) is trading with a trailing P/E of 18.3x, which is lower than the industry average of 28.4x. While this makes RKDL appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Ravi Kumar Distilleries

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.

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 RKDL, 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.

Since RKDL's P/E of 18.3x is lower than its industry peers (28.4x), it means that investors are paying less than they should for each dollar of RKDL's earnings. Therefore, according to this analysis, RKDL is an under-priced stock.

Assumptions to watch out for

While our conclusion might prompt you to buy RKDL immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to RKDL. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with RKDL, then investors would naturally value RKDL at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with RKDL, investors would also value RKDL at a lower price since it is a lower growth investment. Both scenarios would explain why RKDL has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing RKDL to are fairly valued by the market. If this assumption does not hold true, RKDL’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to RKDL. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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:

1. Financial Health: Is RKDL’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
2. Past Track Record: Has RKDL 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 RKDL'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.