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.
HBL Power Systems Limited (NSE:HBLPOWER) is currently trading at a trailing P/E of 28, which is higher than the industry average of 17.1. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
View our latest analysis for HBL Power Systems
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 HBLPOWER
Price-Earnings Ratio = Price per share ÷ Earnings per share
HBLPOWER Price-Earnings Ratio = ₹32 ÷ ₹1.141 = 28x
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 HBLPOWER, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. HBLPOWER’s P/E of 28 is higher than its industry peers (17.1), which implies that each dollar of HBLPOWER’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Electrical companies in IN including Shalimar Wires Industries, LEEL Electricals and LEEL Electricals. You could think of it like this: the market is pricing HBLPOWER as if it is a stronger company than the average of its industry group.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to HBLPOWER. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where HBL Power Systems Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with HBLPOWER 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:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to HBLPOWER. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 urge you to complete your research by taking a look at the following: