In This Article:
I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Tainwala Chemicals and Plastics (India) Limited (NSE:TAINWALCHM) is currently trading at a trailing P/E of 26.2, which is higher than the industry average of 16.2. 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 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 Tainwala Chemicals and Plastics (India)
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 TAINWALCHM
Price-Earnings Ratio = Price per share ÷ Earnings per share
TAINWALCHM Price-Earnings Ratio = ₹86 ÷ ₹3.287 = 26.2x
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 TAINWALCHM, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. TAINWALCHM’s P/E of 26.2 is higher than its industry peers (16.2), which implies that each dollar of TAINWALCHM’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Chemicals companies in IN including Anil, Mysore Petro Chemicals and Hindcon Chemicals. You could also say that the market is suggesting that TAINWALCHM is a stronger business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to TAINWALCHM. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Tainwala Chemicals and Plastics (India) Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to TAINWALCHM may not be 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.