I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.

J Kumar Infraprojects Limited (NSE:JKIL) trades with a trailing P/E of 13.4x, which is lower than the industry average of 18x. 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. 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 J. Kumar Infraprojects

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 JKIL

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

JKIL Price-Earnings Ratio = ₹242.5 ÷ ₹18.047 = 13.4x

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 JKIL, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since JKIL’s P/E of 13.4 is lower than its industry peers (18), it means that investors are paying less for each dollar of JKIL’s earnings. This multiple is a median of profitable companies of 25 Construction companies in IN including ATV Projects India, East Buildtech and MBL Infrastructures. You can think of it like this: the market is suggesting that JKIL is a weaker business than the average comparable company.

Assumptions to be aware of

Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. The first is that our “similar companies” are actually similar to JKIL, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with JKIL, 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 JKIL to are fairly valued by the market. If this is violated, JKIL’s P/E may be lower than its peers as they are actually overvalued by investors.