In This Article:
I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Arvind SmartSpaces Limited (NSE:ARVSMART) trades with a trailing P/E of 15.9x, which is lower than the industry average of 20.6x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
View our latest analysis for Arvind SmartSpaces
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 ARVSMART
Price-Earnings Ratio = Price per share ÷ Earnings per share
ARVSMART Price-Earnings Ratio = ₹135 ÷ ₹8.506 = 15.9x
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 ARVSMART, 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. At 15.9, ARVSMART’s P/E is lower than its industry peers (20.6). This implies that investors are undervaluing each dollar of ARVSMART’s earnings. This multiple is a median of profitable companies of 25 Real Estate companies in IN including Meglon Infra-Real (India), Bronze Infra-Tech and Antariksh Industries. One could put it like this: the market is pricing ARVSMART as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to ARVSMART. 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 ARVSMART, 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 ARVSMART to are fairly valued by the market. If this is violated, ARVSMART’s P/E may be lower than its peers as they are actually overvalued by investors.