This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.

Finolex Cables Limited (NSE:FINCABLES) trades with a trailing P/E of 22.4, which is higher than the industry average of 15. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.

Check out our latest analysis for Finolex Cables

Breaking down the P/E ratio

The P/E ratio is one of many ratios used in relative valuation. 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 FINCABLES

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

FINCABLES Price-Earnings Ratio = ₹483.95 ÷ ₹21.584 = 22.4x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 FINCABLES, 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. Since FINCABLES’s P/E of 22.4 is higher than its industry peers (15), it means that investors are paying more for each dollar of FINCABLES’s earnings. This multiple is a median of profitable companies of 25 Electrical companies in IN including Shalimar Wires Industries, LEEL Electricals and ECE Industries. You could also say that the market is suggesting that FINCABLES is a stronger business than the average comparable company.

Assumptions to be aware of

However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to FINCABLES. If this isn’t the case, the difference in P/E could be due to other factors. For example, Finolex Cables Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to FINCABLES may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.

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 FINCABLES. 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: