This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market. Firstsource Solutions Limited (NSE:FSL) is currently trading at a trailing P/E of 15.3x, which is lower than the industry average of 17.7x. While FSL 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 break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Firstsource Solutions

What you need to know about the P/E ratio

P/E is a popular ratio used for relative valuation. 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 FSL Price-Earnings Ratio = Price per share ÷ Earnings per share FSL Price-Earnings Ratio = ₹73.1 ÷ ₹4.78 = 15.3x The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to FSL, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 15.3x, FSL’s P/E is lower than its industry peers (17.7x). This implies that investors are undervaluing each dollar of FSL’s earnings. This multiple is a median of profitable companies of 25 IT companies in India. So our analysis suggests that FSL is an under-priced stock.

Assumptions to be aware of

However, before you rush out to buy FSL, 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 FSL, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with FSL, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing FSL to are fairly valued by the market. If this does not hold, there is a possibility that FSL’s P/E is lower because our peer group is overvalued by the market.

What this means for you:

Since you may have already conducted your due diligence on FSL, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. 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:

1. Future Outlook: What are well-informed industry analysts predicting for FSL’s future growth? Take a look at our free research report of analyst consensus for FSL’s outlook.

2. Past Track Record: Has FSL been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of FSL’s historicals for more clarity.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements. The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.