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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.
Anjani Portland Cement Limited (NSE:APCL) trades with a trailing P/E of 13x, which is lower than the industry average of 17.3x. While APCL 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 explain what the P/E ratio is as well as what you should look out for when using it.
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What you need to know about 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.
P/E Calculation for APCL
Price-Earnings Ratio = Price per share ÷ Earnings per share
APCL Price-Earnings Ratio = ₹116 ÷ ₹8.927 = 13x
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 APCL, 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. APCL’s P/E of 13 is lower than its industry peers (17.3), which implies that each dollar of APCL’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Basic Materials companies in IN including Oriental Trimex, Saurashtra Cement and Gujarat Sidhee Cement. You can think of it like this: the market is suggesting that APCL is a weaker business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. The first is that our “similar companies” are actually similar to APCL, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with APCL, 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 APCL to are fairly valued by the market. If this does not hold, there is a possibility that APCL’s P/E is lower because our peer group is overvalued by the market.