This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
N R Agarwal Industries Limited (NSE:NRAGRINDQ) is currently trading at a trailing P/E of 8.9x, which is lower than the industry average of 14.3x. While this makes NRAGRINDQ 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for N R Agarwal Industries
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 NRAGRINDQ
Price-Earnings Ratio = Price per share ÷ Earnings per share
NRAGRINDQ Price-Earnings Ratio = ₹510 ÷ ₹57.512 = 8.9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as NRAGRINDQ, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. NRAGRINDQ’s P/E of 8.9 is lower than its industry peers (14.3), which implies that each dollar of NRAGRINDQ’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Packaging companies in IN including Universal Prime Aluminium, SMVD Poly Pack and Everest Kanto Cylinder. You can think of it like this: the market is suggesting that NRAGRINDQ is a weaker business than the average comparable company.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to NRAGRINDQ, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with NRAGRINDQ, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing NRAGRINDQ to are fairly valued by the market. If this does not hold true, NRAGRINDQ’s lower P/E ratio may be because firms in our peer group are overvalued by the market.