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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 better understand how you can grow your money by investing in Tata Elxsi Limited (NSE:TATAELXSI).
Tata Elxsi Limited (NSE:TATAELXSI) trades with a trailing P/E of 34.3x, which is higher than the industry average of 20.8x. While TATAELXSI might seem like a stock to avoid or sell if you own it, 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. See our latest analysis for Tata Elxsi
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 TATAELXSI
Price-Earnings Ratio = Price per share ÷ Earnings per share
TATAELXSI Price-Earnings Ratio = ₹1320.5 ÷ ₹38.54 = 34.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to TATAELXSI, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since TATAELXSI’s P/E of 34.3x is higher than its industry peers (20.8x), it means that investors are paying more than they should for each dollar of TATAELXSI’s earnings. Therefore, according to this analysis, TATAELXSI is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that TATAELXSI should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to TATAELXSI. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with TATAELXSI, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing TATAELXSI to are fairly valued by the market. If this does not hold true, TATAELXSI’s lower P/E ratio may be because firms in our peer group are overvalued by the market.