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This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Godrej Consumer Products Limited (NSE:GODREJCP) trades with a trailing P/E of 54.5, which is higher than the industry average of 36.9. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 Godrej Consumer Products
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 GODREJCP
Price-Earnings Ratio = Price per share ÷ Earnings per share
GODREJCP Price-Earnings Ratio = ₹1452.15 ÷ ₹26.627 = 54.5x
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 GODREJCP, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. GODREJCP’s P/E of 54.5 is higher than its industry peers (36.9), which implies that each dollar of GODREJCP’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 15 Personal Products companies in IN including Rajnish Wellness, Unjha Formulations and Sandu Pharmaceuticals. You could also say that the market is suggesting that GODREJCP is a stronger business than the average comparable company.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. The first is that our “similar companies” are actually similar to GODREJCP. If not, the difference in P/E might be a result of other factors. For example, if Godrej Consumer Products 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 GODREJCP 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.