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.
Dev Information Technology Limited (NSE:DEVIT) trades with a trailing P/E of 9.3x, which is lower than the industry average of 16.8x. While DEVIT might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
View our latest analysis for Dev Information Technology
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 DEVIT
Price-Earnings Ratio = Price per share ÷ Earnings per share
DEVIT Price-Earnings Ratio = ₹67 ÷ ₹7.238 = 9.3x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to DEVIT, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. DEVIT’s P/E of 9.3 is lower than its industry peers (16.8), which implies that each dollar of DEVIT’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 IT companies in IN including Fourth Dimension Solutions, Kellton Tech Solutions and Five Core Exim. You can think of it like this: the market is suggesting that DEVIT is a weaker business than the average comparable company.
A few caveats
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 DEVIT, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with DEVIT, 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 DEVIT to are fairly valued by the market. If this does not hold, there is a possibility that DEVIT’s P/E is lower because our peer group is overvalued by the market.