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PE Ratio: Essential or Controversial Method

Most of the time, in the stock market investments we hear about PE ratios of like: for company X PE ratio has come down to make it more attractive or PE ratio of company Y has gone extremely high to make it overvalued. Do you understand what they mean? If not, Let us try to understand what this ratio is and then we will decide do we need to bother about it or not.

P/E Ratio is nothing but Price to Earnings Ratio. It explains the relationship between the stock price and company’s earnings. It is calculated as below:

                P/E Ratio = (Market Value per Share)/ (Earnings per Share)

Market Value per Share = Current market price of the stock

The earnings per share is the net income of the company from the most recent results published by company divided by number of outstanding shares of the company.

Annual Earnings per Share (EPS) = Net Income / No. of Shares

Example: Canara Bank is having a share price of Rs. 440/- and its EPS is Rs. 84. Then the P/E Ratio of Canara Bank would be 5.24 (440/84).

But what does P/E Ratio explain?

First thing, P/E Ratio gives you an idea of what the market is willing to pay for the company’s earnings. It helps an investor compare the valuations of a stock to that of its peers and in the same industry.

Some Interpretations are:

Higher P/E:  it means that stock is overvalued but market, in expectations of higher earnings growth, is willing to pay that extra money. But, some investors look at it in a different way. They will say company is overpriced as compared to its peers so it is not advisable to pay higher price.

Low P/E Ratio: It indicates “Sign of no-confidence” by the market which means the investors have undervalued the stock due to lack of confidence in its future growth. However, it could also mean that this is a stock which has been overlooked by the market and does possess strong future growth potential.

A low P/E ratio stock can become a “Value pick” before the rest of the market discovers its true value.

Do not depend only on P/E Ratio, but use this as a very directive tool. The PE Ratio should match the growth rate of company. If it is matching the growth rate then you can call it as fairly valued stock. If Growth rate is more than PE Ratio, means the company is undervalued. If Growth rate is less than the PE Ratio, then the company is overvalued.

Let’s try this learning in identifying some value picks based on PE ratios, in the below chart: we mapped the PE ratios of various banks in Increasing order.

 

The average PE ratio of the banking industry is ~10.3 but it does not men all the banks with PE ratio less than 10 are attractive or all the banks with PE ratio more than 11 are costlier to buy. One thing you can notice that most of the banks with PE ratio >11 are private sector banks. intuitionally you can say that the private banks are more nimble in its operations and better managed so their earnings growth is better than public sector banks, so its justified.

Now the issue is how to select our value pick? Let us see in PE ratio chart we can see among Private sector banks Indusind bank and Yes bank had the strongest performance yet the Yes bank has the Lowest PE multiple and Indusind does not have the highest multiple. This indicates that the upside opportunity in Indusind bank and Yes bank is more likely than any other private bank in list. But one should also read and make sure that the strategy of these banks should be aggressive for next few years to sustain their high growth.

Happy investing!!

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IPOs: How to gain from them!

As in last few months lot of IPOs (Initial Public Offers) came in market most of people send the query asking what is an IPO, Is IPO always a better way to make profit, how to go about an IPO to select or reject. In this article we will try to recover some of these queries.

IPO is the way to generate capital/money from market for company’s growth and expansion and in return offering the stake in company. After IPO allotment subscriber receives share of the company and have right to earn the profit from company’s profit.

In the last 4 months almost 30 New companies launched their IPO and some of the companies make a lot of promotions and caught attention from all investors and general public, but this does not signifies IPOs are always good to subscribe or profit from them is assured. Out of last 30 IPOs 21 IPOs have fallen below their list prices and resulted in a loss, please check the table given below for that information:

 

Selection of IPO depends on variety of parameters some of them are:

  • Industry and Business Scenario – The overall sector performance and outlook for an example if some company operating in Automobile sector launches IPO, first thing we should look for who all companies have similar operations and functions. What is the demand of automobile products in the market in India and abroad. How is company’s position with respect to its competitors.
  • Company’s Performance – How are the operations of companies with respect to its competitors, what are the levels of profit, Cash flow, amount of Loan due, reach in market and companies reputation for its product and services.
  • Stock Market condition – How is the stock market moving are people buying more and more share and putting in more money in the market or are they withdrawing from the market. The easiest approximate indicator of this can be movement of Sensex or NIFTY that if it is growing means money flowing in market else vise a versa.

If we will analyse the currently standing IPO of Punjab and Sindh Bank on these parameters, Firstly the banking sector overall has seen tremendous growth in last one year and market is still bullish about their performance due to strong performance of the major clients in MSME sector and high IIP. To check the company’s performance we can see

that the company’s performace is same as their peers and Valuation ratios P/E (Price per share/ Earnings per share) and P/BV (Price per share/Book value per share) indicates that company offers potential to give significant gains but closely analyzing its performance of Financial statement we realize the number of outstanding equity has reduced significantly in 2009 that’s why the valuation looks attractive. Because of less number of shares the Earnings and Book value per share in increased. If we try to take average of last three years we realize the valuation is almost as per its peers , therefore not very attractive to invest in.

lastly from market perspective, currently the market is very volatile it is seeing huge fall and ups in a day so money flow to market is limited people and corporates are not willing to put more money in market, therefore it is not advisable to buy Punjab and Sindh bank IPO. Its better to invest in other big companies which are available at cheap.

Happy Investing!!!!