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.
Schaeffler India Limited (NSE:SCHAEFFLER) trades with a trailing P/E of 35.4, which is higher than the industry average of 21.2. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for Schaeffler India
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 SCHAEFFLER
Price-Earnings Ratio = Price per share ÷ Earnings per share
SCHAEFFLER Price-Earnings Ratio = ₹5401.15 ÷ ₹152.77 = 35.4x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SCHAEFFLER, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. SCHAEFFLER’s P/E of 35.4 is higher than its industry peers (21.2), which implies that each dollar of SCHAEFFLER’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Machinery companies in IN including Revathi Equipment, Revathi Equipment and Envair Electrodyne. You could also say that the market is suggesting that SCHAEFFLER is a stronger business than the average comparable company.
A few caveats
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to SCHAEFFLER. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Schaeffler India Limited is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to SCHAEFFLER may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.