In This Article:
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 begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Amber Enterprises India Limited (NSE:AMBER) is currently trading at a trailing P/E of 40.7, which is higher than the industry average of 25.8. 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for Amber Enterprises India
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 AMBER
Price-Earnings Ratio = Price per share ÷ Earnings per share
AMBER Price-Earnings Ratio = ₹942.25 ÷ ₹23.161 = 40.7x
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 AMBER, 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. Since AMBER’s P/E of 40.7 is higher than its industry peers (25.8), it means that investors are paying more for each dollar of AMBER’s earnings. This multiple is a median of profitable companies of 25 Consumer Durables companies in IN including Powerful Technologies, Jai Mata Glass and Calcom Vision. You could also say that the market is suggesting that AMBER is a stronger business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to AMBER. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Amber Enterprises India 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 AMBER 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.