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.
Gateway Distriparks Limited (NSE:GDL) trades with a trailing P/E of 15.3x, which is lower than the industry average of 19.6x. While GDL 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 Gateway Distriparks
Demystifying the P/E 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 GDL
Price-Earnings Ratio = Price per share ÷ Earnings per share
GDL Price-Earnings Ratio = ₹141 ÷ ₹9.209 = 15.3x
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 GDL, 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. At 15.3, GDL’s P/E is lower than its industry peers (19.6). This implies that investors are undervaluing each dollar of GDL’s earnings. This multiple is a median of profitable companies of 8 Infrastructure companies in IN including IL&FS Transportation Networks, Navkar and VMS Industries. You can think of it like this: the market is suggesting that GDL is a weaker business than the average comparable company.
Assumptions to watch out for
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to GDL, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with GDL, 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 GDL to are fairly valued by the market. If this does not hold true, GDL’s lower P/E ratio may be because firms in our peer group are overvalued by the market.