In This Article:
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Agro Tech Foods Limited (NSE:ATFL) trades with a trailing P/E of 38.9, which is higher than the industry average of 19.3. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
See our latest analysis for Agro Tech Foods
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 ATFL
Price-Earnings Ratio = Price per share ÷ Earnings per share
ATFL Price-Earnings Ratio = ₹528 ÷ ₹13.564 = 38.9x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ATFL, 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. Since ATFL’s P/E of 38.9 is higher than its industry peers (19.3), it means that investors are paying more for each dollar of ATFL’s earnings. This multiple is a median of profitable companies of 25 Food companies in IN including Halder Venture, Kwality and Ovobel Foods. You could also say that the market is suggesting that ATFL is a stronger business than the average comparable company.
Assumptions to watch out for
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to ATFL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Agro Tech Foods Limited is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to ATFL may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be 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 ATFL. 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: