Yahoo Finance Is HDFC Bank Limited’s (NSE:HDFCBANK) PE Ratio A Signal To Sell For Investors?
HDFC Bank Limited (NSEI:HDFCBANK) is trading with a trailing P/E of 28.6x, which is higher than the industry average of 22.7x. 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 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 HDFC Bank
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. 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.
P/E Calculation for HDFCBANK
Price-Earnings Ratio = Price per share ÷ Earnings per share
HDFCBANK Price-Earnings Ratio = ₹2049.35 ÷ ₹71.729 = 28.6x
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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to HDFCBANK, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 28.6x, HDFCBANK’s P/E is higher than its industry peers (22.7x). This implies that investors are overvaluing each dollar of HDFCBANK’s earnings. As such, our analysis shows that HDFCBANK represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that HDFCBANK should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to HDFCBANK, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with HDFCBANK, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing HDFCBANK to are fairly valued by the market. If this is violated, HDFCBANK’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on HDFCBANK, 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:
Future Outlook: What are well-informed industry analysts predicting for HDFCBANK’s future growth? Take a look at our free research report of analyst consensus for HDFCBANK’s outlook.
Past Track Record: Has HDFCBANK 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 HDFCBANK’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.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
