In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
TVS Srichakra (NSE:TVSSRICHAK) is trading with a trailing P/E of 17x, which is lower than the industry average of 19.5x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
See our latest analysis for TVS Srichakra
Breaking down the Price-Earnings 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 TVSSRICHAK
Price-Earnings Ratio = Price per share ÷ Earnings per share
TVSSRICHAK Price-Earnings Ratio = ₹2585.4 ÷ ₹151.677 = 17x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as TVSSRICHAK, 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. Since TVSSRICHAK’s P/E of 17 is lower than its industry peers (19.5), it means that investors are paying less for each dollar of TVSSRICHAK’s earnings. This multiple is a median of profitable companies of 25 Auto Components companies in IN including IST, Ucal Fuel Systems and Enterprises. One could put it like this: the market is pricing TVSSRICHAK as if it is a weaker company than the average company in its industry.
A few caveats
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. The first is that our “similar companies” are actually similar to TVSSRICHAK, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with TVSSRICHAK, 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 TVSSRICHAK to are fairly valued by the market. If this does not hold true, TVSSRICHAK’s lower P/E ratio may be because firms in our peer group are overvalued by the market.