In This Article:
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Reliance Industrial Infrastructure Limited (NSE:RIIL) is currently trading at a trailing P/E of 45.5, which is higher than the industry average of 12.9. 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
View our latest analysis for Reliance Industrial Infrastructure
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 RIIL
Price-Earnings Ratio = Price per share ÷ Earnings per share
RIIL Price-Earnings Ratio = ₹327.95 ÷ ₹7.2 = 45.5x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to RIIL, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 45.5, RIIL’s P/E is higher than its industry peers (12.9). This implies that investors are overvaluing each dollar of RIIL’s earnings. This multiple is a median of profitable companies of 19 Oil and Gas companies in IN including Chennai Petroleum, Hindustan Petroleum and Indian Oil. You could think of it like this: the market is pricing RIIL as if it is a stronger company than the average of its industry group.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to RIIL. If this isn’t the case, the difference in P/E could be due to other factors. For example, Reliance Industrial Infrastructure 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. Of course, it is possible that the stocks we are comparing with RIIL are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.