In This Article:
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
GPT Infraprojects Limited (NSE:GPTINFRA) is currently trading at a trailing P/E of 13.6x, which is lower than the industry average of 16.2x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for GPT Infraprojects
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for 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 GPTINFRA
Price-Earnings Ratio = Price per share ÷ Earnings per share
GPTINFRA Price-Earnings Ratio = ₹94.25 ÷ ₹6.944 = 13.6x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to GPTINFRA, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since GPTINFRA’s P/E of 13.6 is lower than its industry peers (16.2), it means that investors are paying less for each dollar of GPTINFRA’s earnings. This multiple is a median of profitable companies of 25 Construction companies in IN including ATV Projects India, CMM Infraprojects and East Buildtech. One could put it like this: the market is pricing GPTINFRA as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
However, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to GPTINFRA, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with GPTINFRA, 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 GPTINFRA to are fairly valued by the market. If this does not hold, there is a possibility that GPTINFRA’s P/E is lower because our peer group is overvalued by the market.