In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Johnson Controls-Hitachi Air Conditioning India Limited (NSE:JCHAC) trades with a trailing P/E of 48.8, which is higher than the industry average of 20.8. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
View our latest analysis for Johnson Controls-Hitachi Air Conditioning India
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for 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 JCHAC
Price-Earnings Ratio = Price per share ÷ Earnings per share
JCHAC Price-Earnings Ratio = ₹1602 ÷ ₹32.819 = 48.8x
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 JCHAC, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since JCHAC’s P/E of 48.8 is higher than its industry peers (20.8), it means that investors are paying more for each dollar of JCHAC’s earnings. This multiple is a median of profitable companies of 25 Consumer Durables companies in IN including Powerful Technologies, Pulz Electronics and Jaipan Industries. You could think of it like this: the market is pricing JCHAC as if it is a stronger company than the average of its industry group.
Assumptions to watch out for
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to JCHAC. If not, the difference in P/E might be a result of other factors. For example, Johnson Controls-Hitachi Air Conditioning India Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to JCHAC 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.