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.
ITI Limited (NSE:ITI) trades with a trailing P/E of 27.4, which is higher than the industry average of 19.2. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, 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 ITI
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 ITI
Price-Earnings Ratio = Price per share ÷ Earnings per share
ITI Price-Earnings Ratio = ₹86.6 ÷ ₹3.158 = 27.4x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as ITI, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. ITI’s P/E of 27.4 is higher than its industry peers (19.2), which implies that each dollar of ITI’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 22 Communications companies in IN including Catvision, Vindhya Telelinks and Vindhya Telelinks. You could also say that the market is suggesting that ITI is a stronger business than the average comparable company.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to ITI. If this isn’t the case, the difference in P/E could be due to other factors. For example, ITI Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with ITI are not 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.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in ITI. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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: