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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 start learning about core concepts of fundamental analysis on practical examples from today’s market.
Tokyo Plast International Limited (NSE:TOKYOPLAST) trades with a trailing P/E of 9.7x, which is lower than the industry average of 20.8x. While this makes TOKYOPLAST appear like a great stock to buy, 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 Tokyo Plast International
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 TOKYOPLAST
Price-Earnings Ratio = Price per share ÷ Earnings per share
TOKYOPLAST Price-Earnings Ratio = ₹40.95 ÷ ₹4.23 = 9.7x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to TOKYOPLAST, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since TOKYOPLAST’s P/E of 9.7 is lower than its industry peers (20.8), it means that investors are paying less for each dollar of TOKYOPLAST’s earnings. This multiple is a median of profitable companies of 24 Consumer Durables companies in IN including Powerful Technologies, Pulz Electronics and Jaipan Industries. One could put it like this: the market is pricing TOKYOPLAST as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to TOKYOPLAST. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with TOKYOPLAST, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing TOKYOPLAST to are fairly valued by the market. If this does not hold true, TOKYOPLAST’s lower P/E ratio may be because firms in our peer group are overvalued by the market.