Yahoo Finance Should You Be Tempted To Sell India Power Corporation Limited (NSE:DPSCLTD) Because Of Its PE Ratio?
I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
India Power Corporation Limited (NSE:DPSCLTD) trades with a trailing P/E of 78.5, which is higher than the industry average of 12.3. Though this might seem to be a negative, 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.
See our latest analysis for India Power
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 DPSCLTD
Price-Earnings Ratio = Price per share ÷ Earnings per share
DPSCLTD Price-Earnings Ratio = ₹16 ÷ ₹0.204 = 78.5x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to DPSCLTD, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 78.5, DPSCLTD’s P/E is higher than its industry peers (12.3). This implies that investors are overvaluing each dollar of DPSCLTD’s earnings. This multiple is a median of profitable companies of 8 Electric Utilities companies in IN including Tata Power, Reliance Infrastructure and SJVN. You could think of it like this: the market is pricing DPSCLTD as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to DPSCLTD. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where India Power Corporation Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to DPSCLTD may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being 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 DPSCLTD. 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 DPSCLTD’s future growth? Take a look at our free research report of analyst consensus for DPSCLTD’s outlook.
Past Track Record: Has DPSCLTD been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of DPSCLTD’s historicals for more clarity.
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 editorial-team@simplywallst.com.
