Should You Be Tempted To Buy KPIT Technologies Limited (NSE:KPIT) At Its Current PE Ratio?

KPIT Technologies Limited (NSEI:KPIT) is currently trading at a trailing P/E of 18.4x, which is lower than the industry average of 18.6x. 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. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for KPIT Technologies

Breaking down the P/E ratio

The P/E ratio is one of many ratios used in 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.

Formula

Price-Earnings Ratio = Price per share ÷ Earnings per share

P/E Calculation for KPIT

Price per share = ₹220.95

Earnings per share = ₹11.984

∴ Price-Earnings Ratio = ₹220.95 ÷ ₹11.984 = 18.4x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as KPIT, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use below. 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.

KPIT’s P/E of 18.4x is lower than its industry peers (18.6x), which implies that each dollar of KPIT’s earnings is being undervalued by investors. As such, our analysis shows that KPIT represents an under-priced stock.

A few caveats

However, before you rush out to buy KPIT, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to KPIT. 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 KPIT, then KPIT’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 KPIT. In this case, KPIT’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 KPIT to are fairly valued by the market. If this assumption does not hold true, KPIT’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 KPIT. 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 urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for KPIT’s future growth? Take a look at our free research report of analyst consensus for KPIT’s outlook.
2. Past Track Record: Has KPIT 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 KPIT’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.