In This Article:
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.
STL Global Limited (NSE:SGL) trades with a trailing P/E of 1x, which is lower than the industry average of 13.3x. While this makes SGL appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, 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 STL Global
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 SGL
Price-Earnings Ratio = Price per share ÷ Earnings per share
SGL Price-Earnings Ratio = ₹11 ÷ ₹11.369 = 1x
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 SGL, 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 1, SGL’s P/E is lower than its industry peers (13.3). This implies that investors are undervaluing each dollar of SGL’s earnings. This multiple is a median of profitable companies of 25 Luxury companies in IN including Alka India, Advance Lifestyles and Ashima. One could put it like this: the market is pricing SGL as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. The first is that our “similar companies” are actually similar to SGL, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with SGL, 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 SGL to are fairly valued by the market. If this is violated, SGL’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on SGL, the undervaluation of the stock may mean it is a good time to top up on 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 urge you to complete your research by taking a look at the following: