Should You Be Tempted To Sell Edelweiss Financial Services Limited (NSE:EDELWEISS) Because Of Its PE Ratio?

Edelweiss Financial Services Limited (NSEI:EDELWEISS) is trading with a trailing P/E of 27.8x, which is higher than the industry average of 24.1x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Edelweiss Financial Services

Breaking down the Price-Earnings 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.

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to EDELWEISS, 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 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.

At 27.8x, EDELWEISS’s P/E is higher than its industry peers (24.1x). This implies that investors are overvaluing each dollar of EDELWEISS’s earnings. As such, our analysis shows that EDELWEISS represents an over-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to sell your EDELWEISS shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to EDELWEISS. 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 EDELWEISS, then EDELWEISS’s P/E would naturally be higher since investors would reward EDELWEISS’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with EDELWEISS, EDELWEISS’s P/E would again be higher since investors would reward EDELWEISS’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing EDELWEISS to are fairly valued by the market. If this assumption does not hold true, EDELWEISS’s higher P/E ratio may be because firms in our peer group are being undervalued by the market.

What this means for you:

If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in EDELWEISS. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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:

1. Future Outlook: What are well-informed industry analysts predicting for EDELWEISS’s future growth? Take a look at our free research report of analyst consensus for EDELWEISS’s outlook.
2. Past Track Record: Has EDELWEISS 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 EDELWEISS's historicals for more clarity.
3. 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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.