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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.
Aditya Birla Capital Limited (NSE:ABCAPITAL) is trading with a trailing P/E of 29.5, which is higher than the industry average of 15.7. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for Aditya Birla Capital
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 ABCAPITAL
Price-Earnings Ratio = Price per share ÷ Earnings per share
ABCAPITAL Price-Earnings Ratio = ₹116.95 ÷ ₹3.958 = 29.5x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ABCAPITAL, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. ABCAPITAL’s P/E of 29.5 is higher than its industry peers (15.7), which implies that each dollar of ABCAPITAL’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Diversified Financial companies in IN including Saraswati Commercial (India), Available Finance and Minolta Finance. You could also say that the market is suggesting that ABCAPITAL is a stronger business than the average comparable company.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to ABCAPITAL. If this isn’t the case, the difference in P/E could be due to other factors. For example, Aditya Birla Capital 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 ABCAPITAL are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.