In This Article:
I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Bharat Bijlee Limited (NSE:BBL) trades with a trailing P/E of 8.4x, which is lower than the industry average of 15.6x. While BBL might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 Bijlee
Breaking down the Price-Earnings 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 BBL
Price-Earnings Ratio = Price per share ÷ Earnings per share
BBL Price-Earnings Ratio = ₹1152.4 ÷ ₹137.385 = 8.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 BBL, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. BBL’s P/E of 8.4 is lower than its industry peers (15.6), which implies that each dollar of BBL’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Electrical companies in IN including Shalimar Wires Industries, LEEL Electricals and ECE Industries. You can think of it like this: the market is suggesting that BBL is a weaker business than the average comparable company.
A few caveats
However, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to BBL, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with BBL, 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 BBL to are fairly valued by the market. If this does not hold true, BBL’s lower P/E ratio may be because firms in our peer group are 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 undervaluation could signal a good buying opportunity to increase your exposure to BBL. 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 urge you to complete your research by taking a look at the following: