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.
Colgate-Palmolive (India) Limited (NSE:COLPAL) trades with a trailing P/E of 41, which is higher than the industry average of 34.2. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. 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 Colgate-Palmolive (India)
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 COLPAL
Price-Earnings Ratio = Price per share ÷ Earnings per share
COLPAL Price-Earnings Ratio = ₹1095 ÷ ₹26.719 = 41x
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 COLPAL, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since COLPAL’s P/E of 41 is higher than its industry peers (34.2), it means that investors are paying more for each dollar of COLPAL’s earnings. This multiple is a median of profitable companies of 15 Personal Products companies in IN including Unjha Formulations, Cupid and Sandu Pharmaceuticals. You could think of it like this: the market is pricing COLPAL as if it is a stronger company than the average of its industry group.
A few caveats
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 COLPAL. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Colgate-Palmolive (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. Of course, it is possible that the stocks we are comparing with COLPAL are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.