Does Wipro Limited's (NSE:WIPRO) PE Ratio Signal A Buying Opportunity?

Wipro Limited (NSEI:WIPRO) is currently trading at a trailing P/E of 16.7x, which is lower than the industry average of 19.6x. While WIPRO might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 Wipro

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. 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.

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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to WIPRO, such as capital structure and profitability. 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.

At 16.7x, WIPRO’s P/E is lower than its industry peers (19.6x). This implies that investors are undervaluing each dollar of WIPRO’s earnings. Therefore, according to this analysis, WIPRO is an under-priced stock.

Assumptions to watch out for

However, before you rush out to buy WIPRO, 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 WIPRO. 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 WIPRO, then WIPRO’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 WIPRO. In this case, WIPRO’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 WIPRO to are fairly valued by the market. If this assumption does not hold true, WIPRO’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 WIPRO, 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. Future Outlook: What are well-informed industry analysts predicting for WIPRO’s future growth? Take a look at our free research report of analyst consensus for WIPRO’s outlook.
2. Past Track Record: Has WIPRO 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 WIPRO'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.