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.
Housing Development and Infrastructure Limited (NSE:HDIL) is trading with a trailing P/E of 11.6x, which is lower than the industry average of 22.8x. While this makes HDIL 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.
View our latest analysis for Housing Development and Infrastructure
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. 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 HDIL
Price-Earnings Ratio = Price per share ÷ Earnings per share
HDIL Price-Earnings Ratio = ₹30.1 ÷ ₹2.605 = 11.6x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as HDIL, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 11.6, HDIL’s P/E is lower than its industry peers (22.8). This implies that investors are undervaluing each dollar of HDIL’s earnings. This multiple is a median of profitable companies of 25 Real Estate companies in IN including Meglon Infra-Real (India), Bronze Infra-Tech and Antariksh Industries. One could put it like this: the market is pricing HDIL as if it is a weaker company than the average company in its industry.
A few caveats
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to HDIL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with HDIL, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing HDIL to are fairly valued by the market. If this is violated, HDIL’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to HDIL. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following: