The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Honda Siel Power Products Limited (NSE:HONDAPOWER) trades on a trailing P/E of 21. This isn’t too far from the industry average (which is 20.8). Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 Honda Siel Power Products
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 HONDAPOWER
Price-Earnings Ratio = Price per share ÷ Earnings per share
HONDAPOWER Price-Earnings Ratio = ₹1280.6 ÷ ₹60.985 = 21x
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 HONDAPOWER, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Honda Siel Power Products Limited (NSE:HONDAPOWER) is currently trading at a trailing P/E of 21, which is close to the industry average of 20.8. This multiple is a median of profitable companies of 25 Machinery companies in IN including Revathi Equipment, Revathi Equipment and Envair Electrodyne. You can think of it like this: the market is suggesting that HONDAPOWER has similar prospects to its peers in the same industry.
Assumptions to watch out for
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to HONDAPOWER. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where Honda Siel Power Products Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with HONDAPOWER are not 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.