In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Goldiam International Limited (NSE:GOLDIAM) is trading with a trailing P/E of 7.2x, which is lower than the industry average of 13.6x. 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.
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Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 GOLDIAM
Price-Earnings Ratio = Price per share ÷ Earnings per share
GOLDIAM Price-Earnings Ratio = ₹76 ÷ ₹10.485 = 7.2x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as GOLDIAM, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 7.2, GOLDIAM’s P/E is lower than its industry peers (13.6). This implies that investors are undervaluing each dollar of GOLDIAM’s earnings. This multiple is a median of profitable companies of 25 Luxury companies in IN including Alka India, Advance Lifestyles and Lypsa Gems & Jewellery. One could put it like this: the market is pricing GOLDIAM as if it is a weaker company than the average company in its industry.
A few caveats
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 GOLDIAM. 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 GOLDIAM, 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 GOLDIAM to are fairly valued by the market. If this does not hold, there is a possibility that GOLDIAM’s P/E is lower because our peer group is overvalued by the market.