Websol Energy System Limited (NSEI:WEBELSOLAR) is trading with a trailing P/E of 4.2x, which is lower than the industry average of 20.3x. 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Websol Energy System
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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for WEBELSOLAR
Price per share = ₹141.25
Earnings per share = ₹33.744
∴ Price-Earnings Ratio = ₹141.25 ÷ ₹33.744 = 4.2x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 WEBELSOLAR, such as company lifetime and products sold. 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.
WEBELSOLAR’s P/E of 4.2x is lower than its industry peers (20.3x), which implies that each dollar of WEBELSOLAR’s earnings is being undervalued by investors. As such, our analysis shows that WEBELSOLAR represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy WEBELSOLAR immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to WEBELSOLAR. 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 WEBELSOLAR, then investors would naturally value WEBELSOLAR at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with WEBELSOLAR, investors would also value WEBELSOLAR at a lower price since it is a lower growth investment. Both scenarios would explain why WEBELSOLAR has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing WEBELSOLAR to are fairly valued by the market. If this assumption does not hold true, WEBELSOLAR’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:Since you may have already conducted your due diligence on WEBELSOLAR, 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. Financial Health: Is WEBELSOLAR’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 WEBELSOLAR 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 WEBELSOLAR’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.