In This Article:
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Bharat Forge Limited (NSE:BHARATFORG) trades with a trailing P/E of 35.2, which is higher than the industry average of 18.5. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
View our latest analysis for Bharat Forge
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 BHARATFORG
Price-Earnings Ratio = Price per share ÷ Earnings per share
BHARATFORG Price-Earnings Ratio = ₹576.9 ÷ ₹16.376 = 35.2x
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 BHARATFORG, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 35.2, BHARATFORG’s P/E is higher than its industry peers (18.5). This implies that investors are overvaluing each dollar of BHARATFORG’s earnings. This multiple is a median of profitable companies of 25 Auto Components companies in IN including Ucal Fuel Systems, IST and Enterprises. You could also say that the market is suggesting that BHARATFORG is a stronger business than the average comparable company.
A few caveats
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to BHARATFORG. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Bharat Forge Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to BHARATFORG may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.