In This Article:
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in Wheels India Limited (NSE:WHEELS).
Wheels India Limited (NSE:WHEELS) trades with a trailing P/E of 40.3x, which is higher than the industry average of 24.2x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Wheels India
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 WHEELS
Price-Earnings Ratio = Price per share ÷ Earnings per share
WHEELS Price-Earnings Ratio = ₹2512.25 ÷ ₹62.41 = 40.3x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to WHEELS, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 40.3x, WHEELS’s P/E is higher than its industry peers (24.2x). This implies that investors are overvaluing each dollar of WHEELS’s earnings. Therefore, according to this analysis, WHEELS is an over-priced stock.
A few caveats
However, before you rush out to sell your WHEELS 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 WHEELS. 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 WHEELS, 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 WHEELS to are fairly valued by the market. If this does not hold true, WHEELS’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 WHEELS. 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 highly recommend you to complete your research by taking a look at the following: