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MM Forgings Limited (NSEI:MMFL) is currently trading at a trailing P/E of 24.6x, which is higher than the industry average of 20.1x. While MMFL 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 MM Forgings
What you need to know about the P/E ratio
P/E is a popular ratio used for 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 MMFL
Price-Earnings Ratio = Price per share ÷ Earnings per share
MMFL Price-Earnings Ratio = ₹1096.5 ÷ ₹44.632 = 24.6x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 MMFL, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. MMFL’s P/E of 24.6x is higher than its industry peers (20.1x), which implies that each dollar of MMFL’s earnings is being overvalued by investors. Therefore, according to this analysis, MMFL is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your MMFL shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to MMFL, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with MMFL, 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 MMFL to are fairly valued by the market. If this does not hold, there is a possibility that MMFL’s P/E is lower because our peer group is overvalued by the market.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.