Is Varun Beverages Limited's (NSE:VBL) PE Ratio A Signal To Sell For Investors?

I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Varun Beverages Limited (NSE:VBL).

Varun Beverages Limited (NSE:VBL) trades with a trailing P/E of 63.3x, which is higher than the industry average of 27.5x. 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Varun Beverages

Demystifying the P/E ratio

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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.

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 VBL, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will 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 63.3x, VBL’s P/E is higher than its industry peers (27.5x). This implies that investors are overvaluing each dollar of VBL’s earnings. As such, our analysis shows that VBL represents an over-priced stock.

Assumptions to be aware of

However, before you rush out to sell your VBL shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to VBL. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with VBL, then VBL’s P/E would naturally be higher since investors would reward VBL’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with VBL, VBL’s P/E would again be higher since investors would reward VBL’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing VBL to are fairly valued by the market. If this assumption does not hold true, VBL’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 VBL. 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 VBL’s future growth? Take a look at our free research report of analyst consensus for VBL’s outlook.
2. Past Track Record: Has VBL 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 VBL'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.