During any of technical analysis or reading any of the analyst’s report, we investors come across these metrics called PE ratio.

Let’s understand what this PE ratio is all about.

PE ratio comprises of two important factors

  1. Price: This is the current market price of the stock at which it trades
  2. EPS: EPS is earnings per share. This means the net profit of the underlying company attributed to a unit shareholder.

EPS is realized in two forms by the analysts around the globe

  1. Forward EPS: This EPS gives future earnings of the company. This is generally used to construct a proforma or future projection for analysis
  2. Trailing 12 months: This EPS is the last 12 month averaged EPS. This value is based on historical actual data and it is used for comparative analysis.

The ratio of the two entities i.e. Price/EPS gives rise to PE ratio. With two types of EPS we get two different types of PEs a) Forward PE and b) Trailing 12 months PE.

Why PE ratio is an important metric for evaluating the stock performance

PE multiple is generally used by analysts and investors for evaluating the relative performance of the stock with respect to its peer. This ratio tells the amount we investors have to invest to receive a unit of the company’s earnings.

It is a very important multiple for a relative valuation of a stock.

This ratio conveys very important information of stock value – whether they are undervalued, overvalued or fairly valued. Hence, for a stock, we investors can map whether it is a good time to buy an underpriced stock or sell an overpriced stock.

This benchmark PE is the industry median PE for a stock. Every industry has a benchmark PE for reference which is then used to gauge the share price of the stock.

What if the stock has very high PE?

The PE ratio can be high for stock only if either the price is very high or if the earnings per share is very low. The combined effect then produces a very high PE stock.

When a stock trades at fair value and suddenly its EPS drives down to a very low value due to poor performance in the quarter or any time period, the stocks PE skyrockets to a very high value.

E.g. JK Lakshmi Cement once reached 3000x PE.

General characteristics of these stocks are as follows

  1. Overvalued: These stocks are highly overvalued as the market has not adjusted to the price linked to the performance of the stock
  2. Low EPS: Mathematically if the EPS or the denominator in the PE ratio falls below 1, the PE ratio obtained is very high.
  3. High volatility: Generally these stocks have high potential volatility as they are overvalued. The market condition will tame the high price and gradually will reduce the overvalued. Hence, the sustenance of price is less likely.
  4. Unstable growth perspective: The stocks have not performed well in the previous period and most of them are looking for a revival in the market.

Let’s look at the 10 highest PE Stocks in Nifty 500 universe.

10 highest stocks with the highest PE trading in Nifty 500

Unichem Laboratories Ltd. (PE: 1243.4)

Unichem Laboratories Ltd is one of India’s largest and oldest pharmaceutical companies.

The company has more than 500 products registered across the globe. The current valuation as per PE ratio is in the category of highly overvalued. The EPS (trailing twelve months) is below 1 and the company has a negative operating profit margin. The company is looking for a revival in the market both in terms of market share and topline since FY 16.

Future Consumer Ltd. (PE: 865)

Future Consumer Limited was India’s first sourcing-to-supermarket food company headed by the parent company Future Group. The financial durability of the stock is on the average side but price wise it is overvalued. With industrial average PE hovering under 40, this stock is comparatively highly overpriced. The sole reason being EPS very near 0. The most cautious matter in this stock is a negative return on asset for the past 7 years.

Equitas Holdings Ltd. (PE: 404.2)

Equitas Holding Ltd. is an investment company. The primary activity of the company is to make an investment in subsidiary companies and also providing loans to them. This company also has a very low EPS – below 1. The industry in which this company operates has other stocks which are very highly priced e.g. Bajaj Finserv is trading around ₹6435 whereas this stock is priced at ₹117, it might be seen that it is undervalued as per price per se. But this is a myth, it is here where PE gives the true picture of stock being overvalued.

Infibeam Avenues Ltd. (PE: 398.4)

Infibeam Avenues Limited is an Indian internet and e-commerce conglomerate started in 2007. It is involved in digital payments, e-commerce software, online retailing, and internet services. This stock has bearish momentum and the market seems to correct its valuation. But nevertheless, this stock is overvalued with a low basic EPS. The company successfully had recovered the loss in 2015 and thus people have a positive sentiment with this stock irrespective of its fundamental intrinsic financials. Peer group PE for this company hovers around 10.

Ujjivan Financial Services Ltd. (PE: 344)

Ujjivan Financial Services Limited is an NBFC, which started its operation in 2005. It is now the largest microfinance institution. It has one of the highest market capitalizations in its industry. The net profit of the company is good but with a large number of equity shareholders, the EPS drops down below 1. The EBITDA margin for this stock had recently fallen in FY 18. The industry average PE hovers below 20.

Future Retail Ltd. (PE: 330.4)

This is the retail wing of Future Group. Under this Big Bazar, FBB, ezone, hypercity etc. operate. This stock has low EPS but has a strong financial system. It had recently seen a quarter (Q4 FY18) loss but had revived phenomenally. The only issue is the growing contingent liability on its balance sheet.

Indoco Remedies Ltd. (PE: 267.4)

Indoco Remedies Ltd. is a research-oriented pharma company which was incorporated in 1947. Indoco Remedies manufactures and markets formulations and active pharmaceutical ingredients (APIs). The companies have a business in 55-plus countries, including India, USA. The basic EPS has just revived from the past two quarter’s negative value. The industry median PE is around 27 and the stock’s PE is 10x of the industry median.

Mahindra CIE Automation Ltd. (PE: 249.6)

Mahindra CIE is a multi-technology automotive components supplier. This is a subsidiary of the CIE Automotive group of Spain. The parent group is specialized in supplying components and subassemblies for the automotive market, which has a presence across the globe. This stock is financially strong and is the runners up in the race for market capitalization in its segment. Recently it has posted a loss due to a hit in its top line. Even though the market sentiment has been positive and the share price hasn’t dipped much.

Also, read: Why Is Sticking to Your Financial Resolution So Hard?

Coffee Day Enterprise Ltd. (PE: 232.7)

This is the famous parent company of Cafe Coffee Day. It has seen a drastic change of 684% in net profit from the previous year. But recently the EPS dipped due to quarterly poor performance leading to a high PE.

Hathway Cables and Datacom Ltd. (PE: 211.8)

Hathway Cables stock

This company is in the broadcasting of television signals and is an internet service provider. The PE is high because of a low EPS of 0.1. Though having good financial fundamentals, this company is overvalued compared to its peers.

Also, read: Indian automobile sector & the stocks that may be the Eicher of tomorrow

Conclusion

High PE stocks will have better gain potential in the short run or even in the long term. But how high is too high? This always depends on what the investor thinks is high. If there weren’t enough people thinking these stock were worth it, the PE wouldn’t be so high.

This is one of the reasons they sell at a premium or are overvalued. Investors should check management quality before investing in these stocks to assure returns.

Happy Investing!

Disclaimer: the views expressed here are of the author and do not reflect those of Groww. 

 

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