Cyber Media (India) Limited (NSEI:CYBERMEDIA) is trading with a trailing P/E of 15.5x, which is lower than the industry average of 33.2x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, 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 Cyber Media (India)

Demystifying the P/E ratio

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 CYBERMEDIA

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

CYBERMEDIA Price-Earnings Ratio = ₹14.7 ÷ ₹0.946 = 15.5x

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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CYBERMEDIA, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 15.5x, CYBERMEDIA’s P/E is lower than its industry peers (33.2x). This implies that investors are undervaluing each dollar of CYBERMEDIA’s earnings. Therefore, according to this analysis, CYBERMEDIA is an under-priced stock.

Assumptions to watch out for

While our conclusion might prompt you to buy CYBERMEDIA immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to CYBERMEDIA. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with CYBERMEDIA, 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 CYBERMEDIA to are fairly valued by the market. If this does not hold true, CYBERMEDIA’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

What this means for you:

Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to CYBERMEDIA. 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.