Does Vedanta Limited’s (NSE:VEDL) PE Ratio Signal A Buying Opportunity?
Vedanta Limited (NSEI:VEDL) trades with a trailing P/E of 16x, which is lower than the industry average of 19.4x. While VEDL 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. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Vedanta
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. 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 VEDL
Price-Earnings Ratio = Price per share ÷ Earnings per share
VEDL Price-Earnings Ratio = ₹317.4 ÷ ₹19.811 = 16x
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 VEDL, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since VEDL’s P/E of 16x is lower than its industry peers (19.4x), it means that investors are paying less than they should for each dollar of VEDL’s earnings. As such, our analysis shows that VEDL represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy VEDL, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to VEDL. 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 VEDL, 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 VEDL to are fairly valued by the market. If this does not hold, there is a possibility that VEDL’s P/E is lower because our peer group is overvalued by the market.
To help readers see pass 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.
