In This Article:
The content of this article will benefit those of you who are starting to educate yourself about investing in 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.
Bajaj Finserv Limited (NSE:BAJAJFINSV) trades with a trailing P/E of 33x, which is lower than the industry average of 36.2x. While this makes BAJAJFINSV appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, 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 Bajaj Finserv
Breaking down the Price-Earnings 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 BAJAJFINSV
Price-Earnings Ratio = Price per share ÷ Earnings per share
BAJAJFINSV Price-Earnings Ratio = ₹6185.65 ÷ ₹187.481 = 33x
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 BAJAJFINSV, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. BAJAJFINSV’s P/E of 33 is lower than its industry peers (36.2), which implies that each dollar of BAJAJFINSV’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 14 Insurance companies in IN including New India Assurance, New India Assurance and General Insurance of India. One could put it like this: the market is pricing BAJAJFINSV as if it is a weaker company than the average company in its industry.
A few caveats
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to BAJAJFINSV, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with BAJAJFINSV, 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 BAJAJFINSV to are fairly valued by the market. If this does not hold, there is a possibility that BAJAJFINSV’s P/E is lower because our peer group is overvalued by the market.