This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.
Jay Bharat Maruti Limited (NSE:JAYBARMARU) is currently trading at a trailing P/E of 13.4x, which is lower than the industry average of 20.6x. While this makes JAYBARMARU 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 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 Jay Bharat Maruti
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 JAYBARMARU
Price-Earnings Ratio = Price per share ÷ Earnings per share
JAYBARMARU Price-Earnings Ratio = ₹385 ÷ ₹28.728 = 13.4x
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 JAYBARMARU, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 13.4, JAYBARMARU’s P/E is lower than its industry peers (20.6). This implies that investors are undervaluing each dollar of JAYBARMARU’s earnings. This multiple is a median of profitable companies of 25 Auto Components companies in IN including IST, Ucal Fuel Systems and Ucal Fuel Systems. You can think of it like this: the market is suggesting that JAYBARMARU is a weaker business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. The first is that our “similar companies” are actually similar to JAYBARMARU, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with JAYBARMARU, 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 JAYBARMARU to are fairly valued by the market. If this is violated, JAYBARMARU’s P/E may be lower than its peers as they are actually overvalued by investors.