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.
Celebrity Fashions Limited (NSE:CELEBRITY) is currently trading at a trailing P/E of 14.1, which is close to the industry average of 14. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Check out our latest analysis for Celebrity Fashions
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 CELEBRITY
Price-Earnings Ratio = Price per share ÷ Earnings per share
CELEBRITY Price-Earnings Ratio = ₹9.08 ÷ ₹0.644 = 14.1x
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 CELEBRITY, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Celebrity Fashions Limited (NSE:CELEBRITY) is trading with a trailing P/E of 14.1, which is close to the industry average of 14. This multiple is a median of profitable companies of 25 Luxury companies in IN including Alka India, Advance Lifestyles and Lypsa Gems & Jewellery. You can think of it like this: the market is suggesting that CELEBRITY has similar prospects to its peers in the same industry.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to CELEBRITY. If not, the difference in P/E might be a result of other factors. For example, if Celebrity Fashions Limited is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to CELEBRITY may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
Since you may have already conducted your due diligence on CELEBRITY, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. 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 highly recommend you to complete your research by taking a look at the following: