This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between AIA Engineering Limited (NSE:AIAENG)’s fundamentals and stock market performance.

AIA Engineering Limited (NSE:AIAENG) is trading with a trailing P/E of 32.8x, which is higher than the industry average of 26.3x. While AIAENG might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 AIA Engineering

Demystifying the P/E ratio

A common ratio used for relative valuation is the P/E ratio. 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 AIAENG

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

AIAENG Price-Earnings Ratio = ₹1543.15 ÷ ₹47 = 32.8x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to AIAENG, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. AIAENG’s P/E of 32.8x is higher than its industry peers (26.3x), which implies that each dollar of AIAENG’s earnings is being overvalued by investors. Therefore, according to this analysis, AIAENG is an over-priced stock.

Assumptions to be aware of

However, before you rush out to sell your AIAENG shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to AIAENG, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with AIAENG, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing AIAENG to are fairly valued by the market. If this is violated, AIAENG’s P/E may be lower than its peers as they are actually overvalued by investors.

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 rebalance your portfolio and reduce your holdings in AIAENG. 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 urge you to complete your research by taking a look at the following:

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

2. Past Track Record: Has AIAENG 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 AIAENG’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.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.