I am writing today to help inform people who are new to the stock market and want to begin learning the link between 3i Infotech Limited (NSE:3IINFOTECH)’s fundamentals and stock market performance.
3i Infotech Limited (NSE:3IINFOTECH) is trading with a trailing P/E of 9.6x, which is lower than the industry average of 20.4x. 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 out our latest analysis for 3i Infotech
Breaking down the P/E ratio
P/E is a popular ratio used for relative valuation. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for 3IINFOTECH
Price per share = ₹4.22
Earnings per share = ₹0.440
∴ Price-Earnings Ratio = ₹4.22 ÷ ₹0.440 = 9.6x
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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 3IINFOTECH, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
3IINFOTECH’s P/E of 9.6x is lower than its industry peers (20.4x), which implies that each dollar of 3IINFOTECH’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Software companies in IN including Universal Office Automation, MPS Infotecnics and MPS Infotecnics. As such, our analysis shows that 3IINFOTECH represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy 3IINFOTECH immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 3IINFOTECH. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing lower risk firms with 3IINFOTECH, then 3IINFOTECH’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 3IINFOTECH. In this case, 3IINFOTECH’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 3IINFOTECH to are fairly valued by the market. If this assumption does not hold true, 3IINFOTECH’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of 3IINFOTECH to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is 3IINFOTECH’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.
- Past Track Record: Has 3IINFOTECH 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 3IINFOTECH’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.