In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Adroit Infotech Limited (NSE:ADROITINFO) is currently trading at a trailing P/E of 9.4x, which is lower than the industry average of 16.8x. While this makes ADROITINFO appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
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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.
P/E Calculation for ADROITINFO
Price-Earnings Ratio = Price per share ÷ Earnings per share
ADROITINFO Price-Earnings Ratio = ₹26.4 ÷ ₹2.805 = 9.4x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ADROITINFO, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. ADROITINFO’s P/E of 9.4 is lower than its industry peers (16.8), which implies that each dollar of ADROITINFO’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 IT companies in IN including Fourth Dimension Solutions, Cadsys (India) and Quest Softech (India). One could put it like this: the market is pricing ADROITINFO as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to ADROITINFO. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with ADROITINFO, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing ADROITINFO to are fairly valued by the market. If this does not hold, there is a possibility that ADROITINFO’s P/E is lower because our peer group is 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 ADROITINFO. 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: