Despite Its High P/E Ratio, Is ICICI Bank Limited (NSE:ICICIBANK) Still Undervalued?

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use ICICI Bank Limited’s (NSE:ICICIBANK) P/E ratio to inform your assessment of the investment opportunity. What is ICICI Bank’s P/E ratio? Well, based on the last twelve months it is 51.71. That means that at current prices, buyers pay ₹51.71 for every ₹1 in trailing yearly profits.

Check out our latest analysis for ICICI Bank

How Do I Calculate ICICI Bank’s Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for ICICI Bank:

P/E of 51.71 = ₹536.75 ÷ ₹10.38 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price’.

How Does ICICI Bank’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (23.0) for companies in the banks industry is lower than ICICI Bank’s P/E.

NSEI:ICICIBANK Price Estimation Relative to Market, January 2nd 2020
NSEI:ICICIBANK Price Estimation Relative to Market, January 2nd 2020

Its relatively high P/E ratio indicates that ICICI Bank shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

It’s great to see that ICICI Bank grew EPS by 12% in the last year. In contrast, EPS has decreased by 11%, annually, over 5 years.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

How Does ICICI Bank’s Debt Impact Its P/E Ratio?

ICICI Bank has net debt equal to 36% of its market cap. While it’s worth keeping this in mind, it isn’t a worry.

The Verdict On ICICI Bank’s P/E Ratio

With a P/E ratio of 51.7, ICICI Bank is expected to grow earnings very strongly in the years to come. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. Therefore, it’s not particularly surprising that it has a above average P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.