This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Rain Industries Limited (NSE:RAIN).
Rain Industries Limited (NSE:RAIN) is currently trading at a trailing P/E of 7.1x, which is lower than the industry average of 18.1x. While this makes RAIN 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. See our latest analysis for Rain Industries
Demystifying the P/E ratio
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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for RAIN
Price per share = ₹201.3
Earnings per share = ₹28.411
∴ Price-Earnings Ratio = ₹201.3 ÷ ₹28.411 = 7.1x
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. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to RAIN, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use below. 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.
At 7.1x, RAIN’s P/E is lower than its industry peers (18.1x). This implies that investors are undervaluing each dollar of RAIN’s earnings. This multiple is a median of profitable companies of 25 Chemicals companies in IN including Anil, Sysco Industries and Mysore Petro Chemicals. As such, our analysis shows that RAIN represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy RAIN immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to RAIN. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing lower risk firms with RAIN, then RAIN’s P/E would naturally be lower than its peers, since investors would value those with lower risk with a higher price. The other possibility is if you were accidentally comparing higher growth firms with RAIN. In this case, RAIN’s P/E would be lower since investors would also reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing RAIN to are fairly valued by the market. If this assumption is violated, RAIN’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 RAIN, 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:
- Future Outlook: What are well-informed industry analysts predicting for RAIN’s future growth? Take a look at our free research report of analyst consensus for RAIN’s outlook.
- Past Track Record: Has RAIN 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 RAIN’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.