In This Article:
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.
Central Depository Services (India) Limited (NSE:CDSL) is currently trading at a trailing P/E of 27.1, which is higher than the industry average of 17.7. 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.
See our latest analysis for Central Depository Services (India)
Breaking down 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. 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 CDSL
Price-Earnings Ratio = Price per share ÷ Earnings per share
CDSL Price-Earnings Ratio = ₹258.4 ÷ ₹9.543 = 27.1x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CDSL, 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 27.1, CDSL’s P/E is higher than its industry peers (17.7). This implies that investors are overvaluing each dollar of CDSL’s earnings. This multiple is a median of profitable companies of 25 Capital Markets companies in IN including GFL Financials India, VCK Capital Market Services and Elcid Investments. You could think of it like this: the market is pricing CDSL as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to CDSL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Central Depository Services (India) Limited is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with CDSL are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to CDSL. 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 highly recommend you to complete your research by taking a look at the following: