In This Article:
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Vardhman Special Steels Limited (NSE:VSSL) is currently trading at a trailing P/E of 13x, which is lower than the industry average of 13.9x. 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 explain what the P/E ratio is as well as what you should look out for when using it.
See our latest analysis for Vardhman Special Steels
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 VSSL
Price-Earnings Ratio = Price per share ÷ Earnings per share
VSSL Price-Earnings Ratio = ₹121.05 ÷ ₹9.279 = 13x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to VSSL, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 13, VSSL’s P/E is lower than its industry peers (13.9). This implies that investors are undervaluing each dollar of VSSL’s earnings. This multiple is a median of profitable companies of 25 Metals and Mining companies in IN including Bhoruka Aluminium, Golkonda Aluminium Extrusions and Mukand. One could put it like this: the market is pricing VSSL as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to VSSL. 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 VSSL, 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 VSSL to are fairly valued by the market. If this does not hold true, VSSL’s lower P/E ratio may be because firms in our peer group are overvalued by the market.