Vaishali Pharma Limited (NSEI:VAISHALI) is currently trading at a trailing P/E of 29.9x, which is higher than the industry average of 29.5x. While VAISHALI might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Vaishali Pharma
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 VAISHALI
Price per share = ₹66.25
Earnings per share = ₹2.212
∴ Price-Earnings Ratio = ₹66.25 ÷ ₹2.212 = 29.9x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 VAISHALI, 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.
At 29.9x, VAISHALI’s P/E is higher than its industry peers (29.5x). This implies that investors are overvaluing each dollar of VAISHALI’s earnings. Therefore, according to this analysis, VAISHALI is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your VAISHALI 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 VAISHALI. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with VAISHALI, then investors would naturally value VAISHALI at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with VAISHALI, investors would also value VAISHALI at a higher price since it is a higher growth investment. Both scenarios would explain why VAISHALI has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing VAISHALI to are fairly valued by the market. If this assumption does not hold true, VAISHALI’s higher P/E ratio may be because firms in our peer group are being undervalued by the market.
What this means for you:
Since you may have already conducted your due diligence on VAISHALI, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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. Financial Health: Is VAISHALI’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- 2. 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.