United Polyfab Gujarat Limited (NSEI:UNITEDPOLY) is currently trading at a trailing P/E of 19.3x, which is higher than the industry average of 12.5x. While UNITEDPOLY might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, 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 United Polyfab Gujarat

Demystifying the P/E ratio

P/E is often used for relative valuation since earnings power is a chief 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 UNITEDPOLY

Price-Earnings Ratio = Price per share ÷ Earnings per share

UNITEDPOLY Price-Earnings Ratio = ₹35.75 ÷ ₹1.85 = 19.3x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to UNITEDPOLY, 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. Since UNITEDPOLY’s P/E of 19.3x is higher than its industry peers (12.5x), it means that investors are paying more than they should for each dollar of UNITEDPOLY’s earnings. As such, our analysis shows that UNITEDPOLY represents an over-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to sell your UNITEDPOLY shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to UNITEDPOLY. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with UNITEDPOLY, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing UNITEDPOLY to are fairly valued by the market. If this does not hold, there is a possibility that UNITEDPOLY’s P/E is lower because our peer group is overvalued by the market.

What this means for you:

Are you a shareholder? 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 UNITEDPOLY. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.