In This Article:
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Repco Home Finance Limited (NSE:REPCOHOME) is currently trading at a trailing P/E of 16.1x, which is lower than the industry average of 25x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
See our latest analysis for Repco Home Finance
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 REPCOHOME
Price-Earnings Ratio = Price per share ÷ Earnings per share
REPCOHOME Price-Earnings Ratio = ₹554.65 ÷ ₹34.42 = 16.1x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to REPCOHOME, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 16.1, REPCOHOME’s P/E is lower than its industry peers (25). This implies that investors are undervaluing each dollar of REPCOHOME’s earnings. This multiple is a median of profitable companies of 24 Consumer Finance companies in IN including Wall Street Finance, SI Capital & Financial Services and Transcorp International. One could put it like this: the market is pricing REPCOHOME 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 REPCOHOME. 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 REPCOHOME, 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 REPCOHOME to are fairly valued by the market. If this is violated, REPCOHOME’s P/E may be lower than its peers as they are actually overvalued by investors.