I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
General Insurance Corporation of India (NSE:GICRE) is trading with a trailing P/E of 17.8x, which is lower than the industry average of 33.8x. While this makes GICRE 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 explain what the P/E ratio is as well as what you should look out for when using it.
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 GICRE
Price-Earnings Ratio = Price per share ÷ Earnings per share
GICRE Price-Earnings Ratio = ₹323.35 ÷ ₹18.129 = 17.8x
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 GICRE, 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. GICRE’s P/E of 17.8 is lower than its industry peers (33.8), which implies that each dollar of GICRE’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 7 Insurance companies in IN including New India Assurance, ICICI Prudential Life Insurance and Bajaj Finserv. One could put it like this: the market is pricing GICRE as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to GICRE, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with GICRE, 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 GICRE to are fairly valued by the market. If this does not hold, there is a possibility that GICRE’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to GICRE. 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:
- Future Outlook: What are well-informed industry analysts predicting for GICRE’s future growth? Take a look at our free research report of analyst consensus for GICRE’s outlook.
- Financial Health: Are GICRE’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.