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The Supreme Industries Limited (NSEI:SUPREMEIND) trades with a trailing P/E of 37.9x, which is higher than the industry average of 21.3x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. 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 Supreme Industries
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. 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 SUPREMEIND
Price-Earnings Ratio = Price per share ÷ Earnings per share
SUPREMEIND Price-Earnings Ratio = ₹1194.05 ÷ ₹31.472 = 37.9x
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 SUPREMEIND, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. SUPREMEIND’s P/E of 37.9x is higher than its industry peers (21.3x), which implies that each dollar of SUPREMEIND’s earnings is being overvalued by investors. Therefore, according to this analysis, SUPREMEIND is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your SUPREMEIND shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to SUPREMEIND. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with SUPREMEIND, 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 SUPREMEIND to are fairly valued by the market. If this is violated, SUPREMEIND’s P/E may be lower than its peers as they are actually overvalued by investors.
To help readers see pass 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.