This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Kotak Mahindra Bank Limited (BOM:500247).
Kotak Mahindra Bank Limited (BOM:500247) is currently trading at a trailing P/E of 40.3x, which is higher than the industry average of 22.7x. While this makes 500247 appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View out our latest analysis for Kotak Mahindra Bank
Breaking down the P/E ratio
P/E is a popular ratio used for relative valuation. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for 500247
Price per share = ₹1318.8
Earnings per share = ₹32.705
∴ Price-Earnings Ratio = ₹1318.8 ÷ ₹32.705 = 40.3x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 500247, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
Since 500247’s P/E of 40.3x is higher than its industry peers (22.7x), it means that investors are paying more than they should for each dollar of 500247’s earnings. Therefore, according to this analysis, 500247 is an over-priced stock.
A few caveats
However, before you rush out to sell your 500247 shares, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to 500247. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with 500247, then 500247’s P/E would naturally be higher since investors would reward 500247’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with 500247, 500247’s P/E would again be higher since investors would reward 500247’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing 500247 to are fairly valued by the market. If this assumption is violated, 500247’s P/E may be higher than its peers because its peers are actually undervalued by investors.
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 500247. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for 500247’s future growth? Take a look at our free research report of analyst consensus for 500247’s outlook.
- Past Track Record: Has 500247 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 500247’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.