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This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Sakuma Exports Limited (NSE:SAKUMA) trades with a trailing P/E of 7.9x, which is lower than the industry average of 24.6x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for Sakuma Exports
What you need to know about 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. 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 SAKUMA
Price-Earnings Ratio = Price per share ÷ Earnings per share
SAKUMA Price-Earnings Ratio = ₹206.55 ÷ ₹26.218 = 7.9x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SAKUMA, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since SAKUMA’s P/E of 7.9 is lower than its industry peers (24.6), it means that investors are paying less for each dollar of SAKUMA’s earnings. This multiple is a median of profitable companies of 19 Consumer Retailing companies in IN including CKP Products, Tai Industries and Regent Enterprises. You can think of it like this: the market is suggesting that SAKUMA is a weaker business than the average comparable company.
A few caveats
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to SAKUMA. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with SAKUMA, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing SAKUMA to are fairly valued by the market. If this is violated, SAKUMA’s P/E may be lower than its peers as they are actually overvalued by investors.