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This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.
Alembic Pharmaceuticals Limited (NSE:APLLTD) is currently trading at a trailing P/E of 26.3, which is higher than the industry average of 21.8. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 Alembic Pharmaceuticals
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for relative valuation. 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.
P/E Calculation for APLLTD
Price-Earnings Ratio = Price per share ÷ Earnings per share
APLLTD Price-Earnings Ratio = ₹607.95 ÷ ₹23.146 = 26.3x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as APLLTD, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since APLLTD’s P/E of 26.3 is higher than its industry peers (21.8), it means that investors are paying more for each dollar of APLLTD’s earnings. This multiple is a median of profitable companies of 25 Pharmaceuticals companies in IN including Vasundhara Rasayans, Vivimed Labs and Beryl Drugs. You could also say that the market is suggesting that APLLTD is a stronger business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to APLLTD. If not, the difference in P/E might be a result of other factors. For example, Alembic Pharmaceuticals Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with APLLTD are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.