Creative Peripherals and Distribution Limited (NSEI:CREATIVE) is trading with a trailing P/E of 40.3x, which is higher than the industry average of 26x. While this makes CREATIVE appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Creative Peripherals and Distribution
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 CREATIVE
Price per share = ₹135
Earnings per share = ₹3.35
∴ Price-Earnings Ratio = ₹135 ÷ ₹3.35 = 40.3x
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 CREATIVE, 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 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.
Since CREATIVE’s P/E of 40.3x is higher than its industry peers (26x), it means that investors are paying more than they should for each dollar of CREATIVE’s earnings. Therefore, according to this analysis, CREATIVE is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that CREATIVE should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to CREATIVE. 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 riskier firms with CREATIVE, then CREATIVE’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with CREATIVE. In this case, CREATIVE’s P/E would be higher since investors would also reward CREATIVE’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CREATIVE to are fairly valued by the market. If this does not hold, there is a possibility that CREATIVE’s P/E is higher because firms in our peer group are being undervalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to CREATIVE. 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 highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is CREATIVE’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 CREATIVE 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 CREATIVE’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.