Geekay Wires Limited (NSEI:GEEKAYWIRE) trades with a trailing P/E of 27x, which is higher than the industry average of 22.9x. While this makes GEEKAYWIRE appear like a stock to avoid or sell if you own it, 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. View our latest analysis for Geekay Wires

Breaking down the Price-Earnings ratio

The P/E ratio is one of many ratios used in 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 GEEKAYWIRE

Price-Earnings Ratio = Price per share ÷ Earnings per share

GEEKAYWIRE Price-Earnings Ratio = ₹35.1 ÷ ₹1.302 = 27x

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 GEEKAYWIRE, 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 27x, GEEKAYWIRE’s P/E is higher than its industry peers (22.9x). This implies that investors are overvaluing each dollar of GEEKAYWIRE’s earnings. Therefore, according to this analysis, GEEKAYWIRE is an over-priced stock.

Assumptions to watch out for

Before you jump to the conclusion that GEEKAYWIRE should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to GEEKAYWIRE, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with GEEKAYWIRE, 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 GEEKAYWIRE to are fairly valued by the market. If this does not hold, there is a possibility that GEEKAYWIRE’s P/E is lower because our peer group is overvalued by the market.

What this means for you:

Are you a shareholder? 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 GEEKAYWIRE. 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.