Sanwaria Consumer Limited (NSEI:SANWARIA) trades with a trailing P/E of 28.3x, which is higher than the industry average of 22x. While SANWARIA might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Sanwaria Consumer

Breaking down the P/E ratio

P/E is often used for relative valuation since earnings power is a chief 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 SANWARIA

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

SANWARIA Price-Earnings Ratio = ₹16.95 ÷ ₹0.6 = 28.3x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 SANWARIA, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 28.3x, SANWARIA’s P/E is higher than its industry peers (22x). This implies that investors are overvaluing each dollar of SANWARIA’s earnings. Therefore, according to this analysis, SANWARIA is an over-priced stock.

Assumptions to be aware of

Before you jump to the conclusion that SANWARIA should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to SANWARIA. 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 SANWARIA, 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 SANWARIA to are fairly valued by the market. If this does not hold true, SANWARIA’s lower P/E ratio may be because firms in our peer group are overpriced by the market.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.