The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in Arrow Textiles Limited (NSE:ARROWTEX).
Arrow Textiles Limited (NSE:ARROWTEX) is trading with a trailing P/E of 38.5x, which is higher than the industry average of 17x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. 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 Arrow Textiles
Demystifying the P/E 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 ARROWTEX
Price-Earnings Ratio = Price per share ÷ Earnings per share
ARROWTEX Price-Earnings Ratio = ₹32.35 ÷ ₹0.840 = 38.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 ARROWTEX, 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. At 38.5x, ARROWTEX’s P/E is higher than its industry peers (17x). This implies that investors are overvaluing each dollar of ARROWTEX’s earnings. Therefore, according to this analysis, ARROWTEX is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your ARROWTEX shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to ARROWTEX. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with ARROWTEX, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing ARROWTEX to are fairly valued by the market. If this does not hold, there is a possibility that ARROWTEX’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 overvaluation could signal a potential selling opportunity to reduce your exposure to ARROWTEX. 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: