I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Airan Limited (NSE:AIRAN) is currently trading at a trailing P/E of 71.3, which is higher than the industry average of 16.4. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
View our latest analysis for Airan
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 AIRAN
Price-Earnings Ratio = Price per share ÷ Earnings per share
AIRAN Price-Earnings Ratio = ₹57.75 ÷ ₹0.811 = 71.3x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to AIRAN, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 71.3, AIRAN’s P/E is higher than its industry peers (16.4). This implies that investors are overvaluing each dollar of AIRAN’s earnings. This multiple is a median of profitable companies of 25 IT companies in IN including Fourth Dimension Solutions, Quest Softech (India) and Cadsys (India). You could also say that the market is suggesting that AIRAN is a stronger business than the average comparable company.
A few caveats
However, you should be aware that this analysis makes certain assumptions. The first is that our “similar companies” are actually similar to AIRAN. If not, the difference in P/E might be a result of other factors. For example, Airan 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. Of course, it is possible that the stocks we are comparing with AIRAN are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
What this means for you:
Since you may have already conducted your due diligence on AIRAN, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following: