Price per earning ratio is very simple and important metric to decide whether any stock is fairly valued or not. The project PE ratio and it's application has been done by MBA student under my guidance.

1. Deepak Doddamani
TABLE OF CONTENTS
1) INTRODUCTION 4
1.1) OBJECTIVES OF STUDY 4
1.1.1) PRIMARY OBJECTIVES 4
1.1.2) SECONDARY OBJECTIVES 4
1.2) NEED FOR STUDY 4
1.3) SCOPE OF THE STUDY 5
1.4) REASEARCH METHODOLOGY 5
1.4.1) TYPE OF RESEARCH 5
1.4.2) SOURCE OF DATA 5
1.4.3) TOOLS FOR ANALYSIS 5
1.5) BASIS FOR SELECTION OF COMPANIES 5
2) BACKGROUND 7
2.1) STRUCTURE OF BANKING INDUSTRY IN INDIA 7
2.2) LIST OF BANKS IN INDIA 8
2.2.1) Central Bank in India 8
2.2.2) Nationalized Banks 8
2.2.3) Old Private Sector Banks/Societies 9
2.2.4) New private sector banks 9
2.3) Banking Sector companies under study: 10
2.3.1) State Bank of India (SBI) 10
2.3.2) HDFC Bank 10
2.3.3) ICICI Bank 10
2.3.4) Punjab National Bank (PNB) 10
2.3.5) Canara Bank 10
2.4) OTHER DATA ABOUT BANKING SECTOR 11
2.5) Life Science companies 12
2.5.1) Pharmaceutical industry in India 12
2.5.2) Top 20 Pharma Companies in ‘Life Sciences’ category in India : 12
2.6) Life Science Companies under study: 13
2.6.1) Ranbaxy Laboratories Limited 13
2.6.2) Cipla Limited : 13
2.6.3) Lupin Ltd 13
2.6.4) Sun Pharmaceutical Industries 13
2.6.5) Wockhardt Ltd 13
1

2. 2.6.6) Biocon Limited 13
3) METHODOLOGY 15
3.1) LITERATURE REVIEW 15
3.1.1) INVESTMENT 15
3.1.2) ANALYSIS OF STOCKS 16
3.1.3) FUNDAMENTAL ANALYSIS 17
3.1.4) FINANCIAL RATIOS 18
3.1.5) WHAT IS P/E RATIO ? 19
3.1.6) FACTORS WHICH INFLUENCE THE PRICE/EARNINGS RATIO 19
3.1.7) Components of PE Ratio 20
3.1.8) Types of EPS 21
3.1.9) GROWTH OF EARNINGS 23
3.1.10) HOW TO INTERPRET P/E RATIO? 24
3.1.11) Concepts related to P/E 25
3.1.12) PROBLEMS WITH P/E RATIO 26
3.1.13) P/E ratios in India during 1990 and 2005 27
3.1.14) APPLICATIONS OF PE ratio 28
3.2) DATA & OBSERVATIONS 29
3.2.1) PE Ratios of Banking Sector Stocks 29
3.2.2) Determination of P/E values of ‘Banks’. 31
3.2.3) Determination of P/E ratio values of ‘Life Science’ companies: 32
3.3) ANALYSIS and INTERPRETATIONS 33
3.3.1) DATA ANALYSIS & INTERPRETATIONS of BANKING SECTOR STOCK: 34
3.3.2) DATA ANALYSIS & INTERPRETATIONS of LIFE SCIENCES SECTOR STOCKS: 34
3.4) SUGGESTIONS: 35
4) CONCLUSIONS & RECOMMENDATIONS 38
4.1) CONCLUSIONS: 38
4.2) RECOMMENDATIONS: 38
5) LIMITATIONS 40
BIBLIOGRAPHY
2

3. INTRODUCTION
3

4. 1) INTRODUCTION
Every one of us have some ‘financial goals’ and understanding of ‘necessity of investments’.
Investment in Capital Markets is quite confusing. It is very important to understand that
without gaining basic knowledge about ‘Share Market’ investors should not take risk of
investments in highly unpredictable and volatile market. Which stocks to buy? Which to
hold? And which stocks to sell? The decision making process of investor is based on some
solid facts, some historical data, some predictions, some gut feelings and some tips from
experts.
Time plays crucial role in investment decisions. At what price to enter and at what price to
exit from any company stock is as important decision as which stocks to buy. Long position
should be taken when we expect share price to go high and in bear situation we short the
equity. Human have some inherent tendencies like greed, fear, restlessness which also affect
our BUY-SELL decisions. Diversification of portfolio is important to reduce risk. Hence
sector wise understanding of market is also crucial aspect of selecting stocks.
Analysis of stocks can be done using some decision making tools. PE ratio is one of the
simple metric which most of the investors, consultants and institutions use in their investment
related decisions. So we need to understand the importance of P/E ratio and its applications.
1.1) OBJECTIVES OF STUDY
1.1.1) PRIMARY OBJECTIVES
To study the concept of Price Earnings ratio
To study the applications of P/E ratio
1.1.2) SECONDARY OBJECTIVES
To find of P/E ratios of Indian Banking Sector & Pharma sector companies
To do P/E ratio analysis of some of these companies
1.2) NEED FOR STUDY
Valuation of equities is generally not understood properly by investors. Most of the investors
have herd mentality and rely completely on TV channels, Expert Tips for their investment
related decisions. They enter or exit from particular stock at wrong value and incur huge
losses. To avoid such situations we need to study PE ratio, an important decision making tool.
4

5. 1.3) SCOPE OF THE STUDY
The study of PE ratio and its applications is important to understand which stocks are
expensive and which are cheaper. The study is limited to 6-6 Banking & Pharma sector
stocks.
1.4) REASEARCH METHODOLOGY
Research is an art of systematic investigation. The primary purpose of research is
discovering, interpretation and development of method.
1.4.1) TYPE OF RESEARCH
Descriptive research methodology is used for this study. Theoretical study followed by
Observation and analysis is done on the selected stocks.
1.4.2) SOURCE OF DATA
No primary source of data collection is used. Only Secondary source of data is used. Trader
terminal, Broker websites, Equity Research related websites, articles, books etc. used for the
data collection.
1.4.3) TOOLS FOR ANALYSIS
PE values of stocks is used as only tool of analysis
1.5) BASIS FOR SELECTION OF COMPANIES
The most sough-after Banking Sector stocks of the year 2012 (Jan-June) are used as the list
had good combination of Private sector and Public sector. Pharma Sector stock are selected
randomly.
5

6. BACKGROUND
6

7. 2) BACKGROUND
2.1) STRUCTURE OF BANKING INDUSTRY IN INDIA
The Indian banking can be broadly categorized into nationalized (government owned),
private banks and specialized banking institutions. The Reserve Bank of India acts as
centralized body monitoring any discrepancies and shortcoming in the system.
7

8. 2.2) LIST OF BANKS IN INDIA
2.2.1) Central Bank in India
Reserve Bank of India
2.2.2) Nationalized Banks
State Bank of India
State Bank of Bikaner & Jaipur
State Bank of Hyderabad
State Bank of Mysore
State Bank of Patiala
State Bank of Travancore
Allahabad Bank
Andhra Bank
Bank of Baroda
Bank of India
Bank of Maharashtra
Canara Bank
Central Bank of India
Corporation Bank
Dena Bank
IDBI Bank
Indian Bank
Indian Overseas Bank
Oriental Bank of Commerce
Punjab National Bank
Punjab and Sind Bank
Syndicate Bank
Uco Bank
United Bank of India
Union Bank of India
Vijaya Bank
8

9. 2.2.3) Old Private Sector Banks/Societies
Catholic Syrian Bank
City Union Bank
Dhanlaxmi Bank
Federal Bank
Jammu & Kashmir Bank
Karnataka Bank
Karur Vysya Bank
Lakshmi Vilas Bank
Nainital Bank
South Indian Bank
Tamilnad Mercantile Bank
Bank of Rajasthan merged with ICICI Bank in 2010.
Saraswat Bank
2.2.4) New private sector banks
Axis Bank
HDFC Bank
ICICI Bank
IndusInd Bank
ING Vysya Bank
Kotak Mahindra Bank
Yes Bank
DCB Bank
9

10. 2.3) Banking Sector companies under study:
About top banks in India
Listed below are the names of the top banks in India:
2.3.1) State Bank of India (SBI)
Headquartered in Mumbai, State Bank of India (SBI) is the largest financial and banking
services provider in India. It was founded in 1806. The bank offers a range of Personal
Banking, NRI Services, International Banking, Agriculture/Rural Banking, Corporate
Banking and SME Banking services.
2.3.2) HDFC Bank
HDFC Bank was founded in 1994. It is one of the biggest banks in India. Based in Mumbai,
the bank offers a suite of services including accounts and deposits, private banking, credit
cards, payment services and forex services.
2.3.3) ICICI Bank
ICICI Bank is the second biggest bank in India. The bank has 2014 branches and 5,219
ATMs throughout India. ICICI Bank offers a host of services including personal banking,
NRI banking, corporate banking, business banking and agricultural and rural banking.
2.3.4) Punjab National Bank (PNB)
Punjab National Bank (PNB) is the 2nd largest public sector bank in India. It was founded in
1894. Products and services of the bank include personal banking, social banking, corporate
banking and business financing.
2.3.5) Canara Bank
Headquartered in Bangalore, Canara Bank ranks as the 5th biggest bank in India. It was
founded in 1906. It is one of the oldest banks in India. Canara Bank offers products and
services like corporate banking, personal banking, NRI banking and priority and SME credit.
2.3.6) Axis Bank
Axis Bank (erstwhile UTI Bank) was founded in 1994. It is one of the “big four” banks in
India. The products and services include personal, corporate, NRI and priority banking. It is
headquartered in Mumbai.
10

11. 2.4) OTHER DATA ABOUT BANKING SECTOR
We can see that except the global depression period of 2008-2009 Indian sector Banks have
always shown gradual growth.
Some more important recent statistics:
11

12. 2.5) Life Science companies
2.5.1) Pharmaceutical industry in India
The number of purely Indian pharma companies is fairly low. Indian pharma industry is
mainly operated as well as controlled by dominant foreign companies having subsidiaries in
India due to availability of cheap labour in India at lowest cost.
Most of the players in the market are small-to-medium enterprises; 250 of the largest
companies control 70% of the Indian market. Thanks to the 1970 Patent Act, multinationals
represent only 35% of the market, down from 70% thirty years ago.
Most pharma companies operating in India, even the multinationals, employ Indians almost
exclusively from the lowest ranks to high level management. Mirroring the social structure,
firms are very hierarchical. Homegrown pharmaceuticals, like many other businesses in
India, are often a mix of public and private enterprise. Although many of these companies are
publicly owned, leadership passes from father to son and the founding family holds a
majority share.
In terms of the global market, India currently holds a modest 1-2% share, but it has been
growing at approximately 10% per year. India gained its foothold on the global scene with its
innovatively engineered generic drugs and active pharmaceutical ingredients (API), and it is
now seeking to become a major player in outsourced clinical research as well as contract
manufacturing and research.
2.5.2) Top 20 Pharma Companies in ‘Life Sciences’ category in India :
1) Cipla 11) GlaxoSmithKline Pharma
2) Ranbaxy 12) Ipca Pharma
3) Dr. Reddy’s lab 13) Wockhardt
4) Lupin Ltd. 14) Torrent Pharma
5) Aurobindo Pharma 15) Sterling Bio
6) Dabur 16) Biocon
7) Sun Pharma 17) Orchid Chemicals
8) Cadilla Healthcare 18) Alembic
9) Jubiliant LifeScience 19) Aventis Pharma
10) Piramal Heathcare 20) Glenmark Pharma
12

13. 2.6) Life Science Companies under study:
2.6.1) Ranbaxy Laboratories Limited : is an Indian pharmaceutical company that was
incorporated in India in 1961. The company went public in 1973 and Japanese
pharmaceutical company Daiichi Sankyo gained majority control in 2008. Ranbaxy exports
its products to 125 countries with ground operations in 46 and manufacturing facilities in
seven countries. In 2011, Ranbaxy Global Consumer Health Care received the Pharma OTC
Company of the year award.
2.6.2) Cipla Limited : is a prominent Indian pharmaceutical company, best-known outside
its home country for manufacturing low-cost anti-AIDS drugs for HIV-positive patients in
developing countries. It has played a similarly prominent role in expanding access to drugs to
fight influenza, respiratory disease and cancer. Cipla makes drugs to treat cardiovascular
disease, arthritis, diabetes, weight control, depression and many other health conditions, and
its products are distributed in virtually every country of the world.
2.6.3) Lupin Ltd.: is world's largest manufacturer of the anti-TB drugs based
in Mumbai, Maharashtra, India. The company production contains the Cardiovascular (prils
and statins), Diabetology, Asthma, Pediatrics, CNS, GI, Anti-Infectives and NSAIDs therapy
and world largest manufacturer of Anti-TB and Cephalosporins segments.
2.6.4) Sun Pharmaceutical Industries: is an international pharmaceutical company based
in Mumbai,India that manufactures and sells pharmaceutical formulations and active
pharmaceutical ingredients (APIs) primarily in India and the United States. The company
offers formulations in various therapeutic areas,such as cardiology, psychiatry, neurology,
diabetology & gastroenterology . It also provides APIs comprising warfarin, carbamazepine,
etodolac, and clorazepate, as well as anticancers, steroids, peptides, sex hormones, and
controlled substances.
2.6.5) Wockhardt Ltd. Is a pharmaceutical and biotechnology company headquartered
in Mumbai, India. The company has manufacturing plants in
India,UK, Ireland, France and US, and subsidiaries in US, UK, Ireland and France. It is a
global company with more than half of its revenue coming from Europe. It
produces formulations, biopharmaceuticals, nutrition products, vaccines and active
pharmaceutical ingredients(APIs).
2.6.6) Biocon Limited is a global biopharmaceutical company with products and research
services ranging from pre-clinical to clinical development through to commercialization.
Within biopharmaceuticals, the Company manufactures generic active pharmaceutical
ingredients (APIs) like Statins and Immunosuppressants that are sold in the developed
markets of the United States and Europe. It also manufactures biosimilar Insulins, which are
sold in India as branded formulations and in both bulk and formulation forms.
13

14. METHODOLOGY
14

15. 3) METHODOLOGY
3.1) LITERATURE REVIEW
3.1.1) INVESTMENT
In finance, investment is the commitment of funds by buying securities or other
monetary or paper (financial) assets in the money markets or capital markets, or in fairly
liquid real assets, such as gold or collectibles. Valuation is the method for assessing whether
a potential investment is worth its price. Returns on investments will follow the risk-return
spectrum.
Types of financial investments include shares, other equity investment, and bonds
(including bonds denominated in foreign currencies). These financial assets are then expected
to provide income or positive future cash flows, and may increase or decrease in value giving
the investor capital gains or losses.
Trades in contingent claims or derivative securities do not necessarily have future
positive expected cash flows, and so are not considered assets, or strictly speaking, securities
or investments. Nevertheless, since their cash flows are closely related to (or derived from)
those of specific securities, they are often studied as or treated as investments.
Investments are often made indirectly through intermediaries, such as banks, mutual
funds, pension funds, insurance companies, collective investment schemes, and investment
clubs. Though their legal and procedural details differ, an intermediary generally makes an
investment using money from many individuals, each of whom receives a claim on the
intermediary.
Within personal finance, money used to purchase shares, put in a collective
investment scheme or used to buy any asset where there is an element of capital risk is
deemed an investment. Saving within personal finance refers to money put aside, normally on
a regular basis. This distinction is important, as investment risk can cause a capital loss when
an investment is realized, unlike saving(s) where the more limited risk is cash devaluing due
to inflation.
15

16. 3.1.2) ANALYSIS OF STOCKS
Many investors lose their lots of hard-earned money in share market due to lack of
knowledge about the companies in which they invest. It's very important to pick proper
stocks to avoid huge losses in share market. Rather than completely depending on stock tips
by experts; an investor should himself do some basic research about the companies in which
he/she wants to invest. Therefore it's mandatory to have a basic knowledge about the major
methods of analysis of stocks;so as to pick up the right stocks of the right sector at right
price.
The two basic methodologies are
A) Fundamental Analysis
B) Technical Analysis
A) Fundamental Analysis
Fundamental analysis considers financial and economic data that may influence the
viability of a company. The basic of fundamental analysis lies in understanding the business
of the company properly and the industry in which it operates. The fundamentals of a firm
can be analysed quantitatively as well as qualitatively.
Fundamental analysis helps to decide investors whether to buy or sell a particular
stock depending upon its current market price and the intrinsic value. It is useful for investors
in long run as they can buy shares when they are undervalued and sell them when they are
overpriced depending on the market movements.
B) Technical Analysis
Technical analysis involves a study of past market generated data like prices and
volumes to determine the future direction of price movement. As technical analysis focuses
on price and volume data it is extremely useful for traders and speculators who seek to
predict short term price movements.
Basic concepts of technical analysis involves study of trends, relationship
between volume and trend and determination of support and resistance levels.
Investors can use single approach or can use combination of both depending upon
his/her risk appetite, duration of financial goals and investment period.
16

17. 3.1.3) FUNDAMENTAL ANALYSIS
Fundamental Analysis: A method used for the evaluation of intrinsic value of a security
by analyzing financial and economical data of a company/industry using quantitative and
qualitative techniques.
Fundamental analysis uses E-I-A Analysis approach (Economic ----->Industry ------>
Company)
Economic Analysis
• Growth rate of GDP
• Balance of trade
• Foreign reserves and exchanges rates
• Government Budget and Deficit
• Price level and Inflation
• Interest rates
• Savings and investments
• Agriculture and Industrial growth parameters
• Infrastructure facilities and arrangements
• Sentiments
Industry Analysis
• Industry life cycle Analysis
• Profit potential of industries
Company Analysis
• Ratio Analysis
• Valuation of firm
• Non financial analysis
17

18. 3.1.4) FINANCIAL RATIOS
Ratio Analysis is very important quantitative method of Fundamental analysis. Financial
ratios can be broadly categorize as follows:
Liquidity measurement ratios:
Current ratio
Quick ratio
Cash ratio
Profitability indicator ratios:
Return of Assets
Return of Equity
Return on Capital Employed
Debt ratios:
Debt ratio
Debt-Equity ratio
Interest coverage ratio
Operating Performance ratios:
Fixed-Asset turnover
Sales/Revenue per employee
Cash flow indicator ratios:
Operating cash flow/ Sales ratio
Dividend payout ratio
Investment Valuation Ratios:
Per Share data
Price/Earning ratio
Price/Sales ratio
18

19. 3.1.5) WHAT IS P/E RATIO ?
Price per Earnings = Price per share / Earnings per share
The Price per Earnings ratio (PE ratio) is best known investment valuation ratio.
This ratio has two very sensitive components.
The numerator depends on the market expectations and perceptions about the firm's
performance. The denominator represents the earnings left for distribution to the firm's
shareholder after meeting the claims of the debtors. Both components are subject to wide
fluctuations from time to time.
In finance the PE ratio of stock is used to determine how cheap or expensive the share prices
are.The price per share (numerator) is the price of a single share of the stock.The earnings per
share (denominator) is the net income of the company for the most recent 12 month period;
divided by number of shares outstanding.
The PE of a stock describes the price of a share relative to the earnings of the underlying
asset The lower the PE;the less you have to pay for the stock,relative to what you can expect
to earn from it. The higher the PE ratio the more over-valued the stock is.
Example: Suppose if any stock is trading at Rs. 70/- and Earnings per share for the most
recent 12 month period is Rs. 10/- Then the PE ratio = 70/10 = 7
3.1.6) FACTORS WHICH INFLUENCE THE PRICE/EARNINGS RATIO
Tangible factors: These are available in financial statements and can be quantified
1. Profitability
2. Dividend rate
3. Growth rate of past earnings and sales
4. Consistency of past earnings
5. Creditworthiness
6. Financial Strength
7. Historical Performance
Intangible factors: These factors give clear picture of financial position of firm. They
influence the tangible factors to large extent but can not be quantified.
1. Status of the firm
2. Nature of business
3. Quality of management
4. Future growth prospects of industry
5. Competitive nature of the firm
6. Expectations
19

20. 3.1.7) Components of PE Ratio
• Price per share (Market value per share)
• Earnings per share
Market Value
Market Value is the current quoted price at which investors buy or sell a share of
common stock or a bond at a given time. And it is also known as "market price".
Market value is often different from book value because the market takes into account
future growth potential. Most investors who use fundamental analysis to pick stocks look at a
company's market value and then determine whether or not the market value is adequate or if
it's undervalued in comparison to its book value, net assets or some other measure.
Market Average
A measure of the overall price level of a given market, as defined by a specified group
of stocks or other securities. A market average equals the sum of all current values of stocks
in the group divided by the total number of shares in the group.
Earnings per Share
The portion of a company's profit allocated to each outstanding share of common
stock. EPS serves as an indicator of a company's profitability.
The EPS formula does not include preferred dividends for categories outside of
continued operations and net income. Earnings per share for continuing operations and net
income are more complicated in that any preferred dividends are removed from net income
before calculating EPS.
Only preferred dividends actually declared in the current year are subtracted. The
exception is when preferred shares are cumulative, in which case annual dividends are
deducted regardless of whether they have been declared or not. Dividends in arrears are not
relevant when calculating EPS.
20

21. 3.1.8) Types of EPS
On the basis of Shares Outstanding
By definition, EPS is net income divided by the number of shares outstanding;
however, both the numerator and denominator can change depending on how you define
"earnings" and "shares outstanding". Because there are so many ways to define earnings, we
will first tackle shares outstanding.Shares outstanding can be classified as either primary
(primary EPS) or fully diluted (diluted EPS).
• Primary EPS is calculated using the number of shares that have been issued and held
by investors. These are the shares that are currently in the market and can be traded.
• Diluted EPS entails a complex calculation that determines how many shares would
be outstanding if all exercisable warrants, options, etc. were converted into shares at a
point in time, generally the end of a quarter. We prefer diluted EPS because it is a
more conservative number that calculates EPS as if all possible shares were issued
and outstanding. The number of diluted shares can change as share prices fluctuate
On the basis of context of the type of "earnings" being used.
There are five types of EPS
• Reported EPS (or GAAP EPS)
We define reported EPS as the number derived from generally accepted accounting
principles (GAAP); The Company derives these earnings according to the accounting
guidelines used.
A company's reported earnings can be distorted by GAAP. For example, a one-time
gain from the sale of machinery or a subsidiary could be considered as operating income
under GAAP and cause EPS to spike. Also, a company could classify a large lump of normal
operating expenses as an "unusual charge" which can boost EPS because the "unusual
charge" is excluded from calculations. Investors need to read the footnotes in order to decide
what factors should be included in "normal" earnings and make adjustments in their own
calculations.
21

22. • Ongoing EPS
This EPS is calculated based upon normalized or ongoing net income and excludes
anything that is an unusual one-time event. The goal is to find the stream of earnings from
core operations which can be used to forecast future EPS. This can mean excluding a large
one-time gain from the sale of equipment as well as an unusual expense. Attempts to
determine an EPS using this methodology is also called "pro forma" EPS.
• Pro Forma EPS
The words "pro forma" indicate that assumptions were used to derive whatever
number is being discussed. Different from reported EPS, pro forma EPS generally excludes
some expenses/income that were used in calculating reported earnings. For example, if a
company sold a large division, it could, in reporting historical results, exclude the expenses
and revenues associated with that unit. This allows for more of an "apples-to-apples"
comparison.
Headline EPS
The headline EPS is the EPS number that is highlighted in the company's press
release and picked up in the media. Sometimes it is the pro forma number, but it could also be
an EPS number that has been calculated by the analyst/pundit that is discussing the company.
Generally, soundbites do not provide enough information to determine which EPS number is
being used.
Cash EPS
Cash EPS is operating cash flow (not EBITDA) divided by diluted shares outstanding.
We think cash EPS is more important than other EPS numbers because it is a "purer" number.
Cash EPS is better because operating cash flow cannot be manipulated as easily as net
income and represents real cash earned, calculated by including changes in key asset
categories such as receivables and inventories.
22

23. EPS & Extraordinary items
An item included in a company’s Accounts that is not likely to occur again, such as an
Acquisition or sale of assets.
• EPS before extra ordinary items:
EPS calculated before these items included in the account is called EPS before
extra ordinary items.
• EPS after extra ordinary items:
EPS calculated after these items included in the account is called EPS after
extra ordinary items.
3.1.9) GROWTH OF EARNINGS
If a company has a P/E higher than the market or industry average, this means that the
market is expecting big things over the next few months or years. A company with a high P/E
ratio will eventually have to live up to the high rating by substantially increasing its earnings,
or the stock price will need to drop. The P/E ratio is a much better indicator of the value of a
stock than the market price alone. That being said, there are limits to this form of analysis -
you can't just compare the P/Es of two different companies to determine which a better value
is. It's difficult to determine whether a particular P/E is high or low without taking into
account two main factors:
1. Company growth rates - How fast has the company been growing in the past, and
are these rates expected to increase, or at least continue, in the future? Something isn't right if
a company has only grown at 5% in the past and still has a stratospheric P/E. If projected
growth rates don't justify the P/E, then a stock might be overpriced. In this situation, all you
have to do is calculate the P/E using projected EPS.
2. Industry - It is only useful to compare companies if they are in the same industry.
For example, utilities typically have low multiples because they are low growth, stable
industries. In contrast, the technology industry is characterized by phenomenal growth rates
and constant change. Comparing a tech company to a utility is useless. You should only
compare high-growth companies to others in the same industry, or to the industry average.
23

24. 3.1.10) HOW TO INTERPRET P/E RATIO?
Price per earnings ratio interpretation is mainly done considering the environment of the
company in which it operates i.e. industry etc.
1) Compare:
P/E ratio doesn’t have any utility on standalone, isolated basis. This implies that
It should always be used to compare two companies, countries, sectors, countries etc.
It should be used along with other tools of valuation and analysis
2) Criteria of Comparison
It is very important to understand companies operating in same industry can be compared.
Also comparison of P/E ratio of one company to the average P/E of company is allowed.
Thus ‘High P/E’ of company means P/E of that company is higher than average P/E of the
companies in same league.
3) Thumb Rule
Generally companies in mature industries or markets have stable and moderate growth rate.
Such companies have a low to moderate P/E ratio.
Companies in high growth industries or market shows rapid growth.These companies do have
a moderate to high P/E ratio.
Depending on these important aspects of P/E ratio related rules we can interpret:
A) Undefined P/E
A company with no earnings has an undefined P/E ratio. The companies which have huge
losses and have some fundamental issues generally show negative P/E ratio. Even though
mathematically we can calculate such negative P/E ratios by convention they are considered
as ‘undefined’.
B) 0-10
Either the company in undervalued or the earnings of the company are thought to be in
decline.
C) 10-25
This range can be considered a fair value of P/E. The range describes companies which are
either undervalued or are in growing phase. The earnings of the stocks are expected to grow
in future.
D) 25+
Stocks with such higher P/E may show growth potential in the companies. High P/E means
investors are ready to pay premium prices for buying these already overvalued stocks. The
high earnings expectations from such stocks can create speculative bubble sometimes.
Please note, average P/E ratio of companies differ from industry to industry.
24

25. 3.1.11) Concepts related to P/E
Publically traded companies often make quarterly cash payments to their own shareholders,
in direct proportion to the number of shares held. This is termed as dividend.
Consider the formula below:
P/E = P/D * DPR
Here, P/D = Price per dividend ratio &
DPR= Dividend payout ratio = Dividend / EPS
This is how P/E is related to Dividend
We can rewrite the above formula as
P/D = P/E / DPR
Here, reciprocal of DPR is known as Dividend cover (DC)
Therefore, P/D = P/E * DC
Please note;
· P/E ratio and Earning yield are reciprocals
· P/D ratio and Dividend yield are reciprocals
· DPR and DC are reciprocals
ABSOLUTE PE and RELATIVE PE
ABSOLUTE PE:
Absolute PE is the price of a stock divided by the company’s earnings per share. This
measure indicates how much an investor is willing to pay per Rupee of earnings. Absolute PE
represents the PE of the current period
RELATIVE PE:
Relative P/E compares the current absolute P/E to a benchmark or a range of past P/Es over a
relevant time period, such as the last 10 years. Relative P/E shows what portion or percentage
of the past P/Es the current P/E has reached.
The relative P/E will have a value below 100% if the current P/E is lower than the past value
(whether the past high or low). If the relative P/E measure is 100% or more, this tells
investors that the current P/E has reached or surpassed the past value.
25

26. 3.1.12) PROBLEMS WITH P/E RATIO
There are some pitfalls in uses of P/E ratio as follows
Market Sentiment: In bearish market when investors have low interest in equity, most of
the stocks are oversold. The P/E ratio of some good companies may get undervalued, which
could show very less growth prospects to investors.
Accounting methods: Book-keeping and accounting of companies is done according to
guidelines of Generally Accepted Accounting Principle, which may change from time to time
and country to country. Hence value of EPS can be reached in various different ways which
results in confusion while comparing P/Es.
Economic cycles: Business operates in economic cycles. During downturn EPS will be low
but P/E will be inflated or vice versa. In growth phase the investment can be huge. In such
case depreciation can suppress earnings which may mislead the investors.
Inflation: It is important to look earnings over a time while calculating P/E ratio. Inflation
makes this difficult as historical data becomes irrelevant during inflation period. Role of
depreciation and inventory in calculations of EPS may be underestimated during this phase.
Also investors may think that earnings might be artificially distorted upwards.
Interpretation mistakes: Low P/E is fair P/E value to enter in stocks as Low P/E is
interpreted as undervalued stock. This interpretation can become a big mistake sometimes as
low P/E can further decline to enter in negative or undefined P/E ratio zone. This can happen
when some companies are undergoing gradual decline over time.
Not a powerful metric in standalone:
P/E ratio doesn’t give accurate idea about stock movements as there are other parameters
which affect stock prices in market. Margins, cash generating ability, performance over time,
other ratios etc. should be used along with P/E to increase its reliability for decisions
regarding long or short positions of stocks.
Expectations: High P/E ratio of stocks captures eyeballs of investors. The growth
expectations about the stock value sometimes results into heavy buying of such stocks which
in turn leads to overvaluation of stocks.
Negligence: Some companies with good fundamentals don’t get limelight. Their share value
may remain undervalued for longer time as investors, institutions or brokers may neglect it
due to its low P/E value. Thus only actively tracked stocks show high volume of trading.
Relation between high EPS and P/E ratio is tenuous:
Strong growth in earnings doesn’t always translate into high P/E ratios.
Firms with similar growth rate often don’t sell at same P/E ratio
Market determines value on long term expectations rather than short term performance.
26

27. 3.1.13) P/E ratios in India during 1990 and 2005
See Table 1 given below, the price-earnings ratio for companies listed in SENSEX went
down from 19.68 in March 1991 to 16.05 in March 2005, i.e., an average drop of
approximately 1.5% per year. Similarly, the price earnings ratio for companies listed in BSE-
100 dropped by approximately 2.4% per year.
Predictions regarding the Indian Stock Markets during 2005 and 2015
The following three main components are likely to result in a strong upward movement of
Indian markets:
1. During April 2005 and March 2015, companies listed in SENSEX, BSE-100, and BSE-500
are expected to grow at an annual average rate of 11% (in real terms) and 17% (in nominal
terms).
2. In March 31, 2005, the firms in SENSEX were trading at an average P/E ratio of 16.05
whereas they were trading at an average price earnings ratio of 22.8 during 1991 and 2005.
Analysis shows that by December 2015, these firms (that are part of SENSEX, BSE-100, and
BSE-500) are likely to trade at an average P/E ratio of 22.8 also, partly because of volatility
and partly because the annual growth rates of these companies is quite high when compared
to their counterparts in the United States and other developed countries.
3. Since India (and other emerging countries) are growing rapidly – as much as 7-8% more –
than their counterparts in the United States, we believe that the SENSEX, BSE-100, and
BSE-500 will trade at an average price/earnings ratio of 22.8 (during 2005 and 2015).
27

28. 3.1.14) APPLICATIONS OF PE ratio
ANALYTICAL DEVICE:
PE ratio is a valuable analytical device in assisting investors in evaluating stock prices from
long term perspectives and is particularly helpful in difficult analysis of shocking economic
days.
VALUATION TOOL :
Understanding PE gives the investors an idea if the stock has sufficient growth potential.
Stocks with low PE can be considered good bargains as their growth potential is still
unknown to the market.If the PE is high, it warns of an over-priced stock. It means the stock's
price is much higher than its actual growth potential. So these stocks are more liable to crash
drastically.
ESTIMATION OF EPS :
PE ratio encapsulates the level of EPS, the quality of EPS and the future prospects of firm’s
growth potential in EPS.
DECISION MAKING TOOL:
Buy-Hold-Sell related decisions regarding investments in stocks can be easily took
considering the PE value of the stock. Whether to take long position or to short the stocks,
when to exit or when to enter stock etc. decisions can be easily taken when you know how to
interpret PE ratios properly. With the help of PE Ratio and investor can decide whether a
stock is cheap or expensive to purchase. It helps to minimize the risk of investors.
A POWERFUL METRIC:
PE ratio is simple and yet powerful metric from the perspective of retail investors. By
comparing price and earnings per share for a company, one can analyze the market's
valuation of a company’s future earnings potential. Another way to look at this ratio is that, it
indicates the number of years required to pay back the current purchase price of the shares
(ignoring the time value of money) .The PE Ratio of a specific industry can be used to
evaluate the whole market of that industry. You can evaluate the PE Ratio of the stock of a
business by comparing it with standard market PE ratio of that industry.
28

29. 3.2) DATA & OBSERVATIONS
3.2.1) PE Ratios of Banking Sector Stocks
In the table below, PE ratios of Banking stocks as on 13th June 2012 are tabulated.
BANK NAME CMP EPS PE Value
(Rs.) (Rs.) (Ratio)
PUBLIC SECTOR BANKS
State Bank of India 2150. 25 174.46 12.74
Allahabad Bank 137.05 37.33 3.85
Andhra Bank 113.40 24.03 4.82
Bank of Baroda 694.10 121.42 5.92
Bank of India 348.10 46.60 7.65
Bank of Maharashtra 51.10 7.31 7.42
Canara Bank 412.65 74.10 5.83
Central Bank of India 80.45 7.24 11.24
Corporation Bank 438.60 101.67 4.32
Dena Bank 96.35 22.94 4.35
IDBI Bank 90.45 15.89 5.87
Indian Bank 174.95 40.65 4.38
Indian Overseas Bank 89.45 13.18 6.71
Oriental Bank of Commerce 241.45 39.13 6.24
Punjab National Bank 769.45 144.00 5.65
Punjab and Sind Bank 69.25 19.27 3.72
Syndicate Bank 101.30 21.82 4.69
29

30. Uco Bank 78.10 16.68 4.76
United Bank of India 63.80 17.52 3.88
Union Bank of India 208.00 27.01 7.89
Vijaya Bank 58.00 11.72 5.05
OLD PRIVATE SECTOR BANKS
City Union Bank 48.65 6.87 7.21
Dhanalaxmi Bank 54.25 -13.58 - 4.09
Federal Bank 421.80 45.41 9.44
Jammu and Kashmir Bank 912.15 165.65 5.54
Karnataka Bank 86.40 13.07 6.29
Karur Vysya Bank 417.10 46.81 8.81
South Indian Bank 23.60 3.54 6.70
NEW PRIVATE SECTOR BANKS
Axis Bank 1013.05 102.67 10.19
HDFC Bank 534.40 22.02 24.65
ICICI Bank 818.85 56.08 15.14
IndusInd Bank 314.40 17.16 18.74
ING Vysya Bank 331.40 30.40 11.14
Kotak Mahindra Bank 568.20 14.65 39.89
Yes Bank 332.05 27.68 12.50
DCB Bank 40.55 18.07 2.32
Note: CMP = Current Market Price
EPS = Earnings Per Share
30

31. 3.2.2) Determination of P/E values of ‘Banks’.
In the table below, given the data of EPS and Finding the Average Market price of stock on
15th June 2012, the PE Value of top 6 banks (banks under consideration) has been calculated
using formula of PE.
No. BANK NAME Day’s Day’s Average Earnings PE
High Low per Ratio
Market share
(Rs.) (Rs.) Price (EPS) (Value)
(Rs.) (Rs.)
1 State Bank of India (SBI) 2189.85 2147.00 2168.42 174.46 12.42
2 HDFC Bank 549.70 534.95 542.32 22.02 24.62
3 ICICI Bank 855.55 823.15 839.35 56.08 14.96
4 Punjab National Bank (PNB) 795.00 772.55 758.77 144.00 5.27
5 Canara Bank 425.20 411.10 418.15 74.10 5.64
6 Axis Bank 1038.35 1010.00 1024.17 102.67 9.97
Bar Chart Representation of Above data:
25
20
15
PE Value
10
5
0
SBI HDFC ICICI PNB CANARA AXIS
31

32. 3.2.3) Determination of P/E ratio values of ‘Life Science’ companies:
Day’s High-Low prices of the stocks and EPS are used to calculate PE values of below ‘Life
Science’ companies on 15th June 2012.
Company Day’s High Day’s Low Average EPS PE Value
(Rs.) (Rs.) (Rs.) (Rs.) (Ratio)
Ranbaxy 480.70 471.10 475.9 -72.32 - 6.58
Cipla 310.75 304.00 307.37 14.00 21.95
Lupin 518.00 505.10 511.55 18.01 28.40
Sun Pharma 596.50 583.70 590.1 18.62 31.69
Wockhardt 856.20 827.45 841.82 16.81 50.07
Biocon 222.00 216.70 219.35 12.78 17.16
Bar chart representation of above data:
60
50
40
30
PE Value
20
10
0
-10
Ranbaxy Cipla Lupin Sun Pharma Wockhardt Biocon
32

33. 3.3) ANALYSIS and INTERPRETATIONS
ANALYSIS
Analysis of data means studying the tabulated materials in order to determine inherent
facts or meanings. It involves breaking down, existing common factor into simpler parts and
putting the parts together in new arrangements for the purpose of interpretation. This process
require flexible and open mind. No similarities, differences, trends and outstanding factors
should go unnoticed. Large divisions of material should be broken down into smaller units
and rearranged in new combinations to discover new factors and relationships. Data should
be studied from as many angles as possible to find out new and newer facts.
Interpretation
Analysis and interpretation are central steps in the research process. The goal of
analysis is to summarize the collateral data in such a way that they provide answer to
question that triggered the research. Through interpretation the meanings and implications of
the study become clear. Analysis is not complete without interpretation and interpretation
cannot proceed with analysis. This research has two major aspects. First there is the effort to
established continuity in social research through linking the result of one study with those of
another. Secondly interpretation leads to the establishment explanatory concepts.
In the case of P/E analysis of Banks and Life Science companies in this Study, Our
Analysis is solely based on the P/E ratios calculated using Average Share Price on 15th June
2012 and EPS value of 12th March 2012. Banking Sector stock were badly hurt during
slowdown after Greece Crisis and Global economic conditions while Pharma Sector
companies weathered the storm successfully. Hence the ranges of PE values and
Interpretation criteria are different for both the industries.
We will analyse PE values and interpret the results in tabular forms.
33

34. 3.3.1) DATA ANALYSIS & INTERPRETATIONS of BANKING SECTOR STOCK:
Bank Name PE Analysis Interpretation
Value
PE Value
is
SBI 12.42 FAIR Rightly Valued
HDFC 24.62 HIGH Overvalued
ICICI 14.96 FAIR Rightly Valued
PNB 5.27 LOW Undervalued
CANARA 5.64 LOW Undervalued
AXIS 9.97 FAIR Rightly Valued
3.3.2) DATA ANALYSIS & INTERPRETATIONS of LIFE SCIENCES SECTOR
STOCKS:
Pharma PE Value Analysis Interpretation
Company
PE Value is
Name
Ranbaxy -6.58 UNDEFINED Undervalued / Avoided
Cipla 21.95 HIGH Overvalued
Lupin 28.40 HIGH Overvalued
Sun Pharma 31.69 HIGH Overvalued
Wockhardt 50.07 VERY HIGH Highly Overvalued
Biocon 17.16 FAIR Rightly Valued
34

35. 3.4) SUGGESTIONS:
Banks:
Looking at the Bankex performance over the years we can expect the Banking Sector to grow
rapidly. So in for long term investors there is a great opportunity in Banking Sector stocks.
New Private Sector Banks are performing much better than Public Sector Banks and old
public sector banks which reflects in their PE ratios. Hence for Short to mid-term investors
New private Sector banks offers a good stocks for their portfolios.
It has been seen that banking sector stocks have recovered from the oversold positions and
they can be bought at every declines.
From the six banks under study SBI, PNB and Canara are Public Sector Banks while HDFC,
ICICI and AXIS are Private Sector Banks. Hence to avoid unnecessary risks during bear
market later banks should be preferred.
PNB and CANARA banks are undervalued at this time so they can be bought at this time.
SBI bank shares are trading at fair valuations and therefore you can BUY and HOLD them
for some more time.
ICICI and AXIS banks are trading at fair prices and it is the right opportunity to BUY these
stocks. You can stay invested in HDFC banks but should SELL it at downturn rally as HDFC
seems to be overvalued.
Considering the PE Values the best Buying Private Sector Bank in the list is AXIS Bank and
Best Buying Public Sector Bank is SBI Bank.
In Bearish Market most risky option to buy is HDFC while in Bearish Market most risky
Buying Option is CANARA Bank.
Although in long term all six Banks seems to have BUY call. But in mid-term HDFC should
be sold to book profits at right time and can be bought back again at some fair PE value. In
mid-term PNB and CANARA should be shorted if there is bearish situation to avoid losses,
as these two stocks can be unpredictable due to its PE ratio values and Public Sector nature.
SBI seems to be right Public Sector Bank to stay invested in for mid-to-long term.
These all suggestions are based on the analysis and interpretation of PE Values only. To
further make choices accurate one should consider other fundamental factors about the
company, future projects, quarterly results, recent news and other important ratios.
35

36. Pharma:
Pharmaceutical companies are growing rapidly due to innovative technologies and import of
high operating standards of global parent companies. Based on the P/E ratio analysis of the
six ‘lifestyle companies’ we can suggest:
Investors have lot of growth expectations from Pharmaceutical companies and therefore are
ready to pay more per rupee of earnings from Pharma Stocks. So the investor must hold some
Pharma stocks in his portfolio; to minimize the risks of bear market fall.
Whenever Market is bullish Pharma stocks are first movers and whenever market falls they
move last, i.e. don’t crash.Hence PE values for some companies can be very high.
From the list studied we can easily see that Ranbaxy has negative PE Value, which shows can
be due to some management related or fundamental issues. It’s better to avoid Ranbaxy at
this stage even if prima facie it seems be highly undervalued. Ranbaxy shares can be bought
at when PE value enters in less risky range of 5-10. Although investors with high risk
apetite can invest in it at this stage for long term.
Wockhardt seems to be highly overvalued and it can be a speculative bubble. Avoid Buying
such stocks as you will end up on wrong side when the market will start falling. Investment is
such already inflated stocks doesn’t make any sense. As we must stick to the ‘Buy Low, Sell
high’ rule to minimize our losses. On every peak there will be some profit booking by FIIs
and that is when you can short sell and cover position after downward rally. Small investors
should not indulge in short selling and therefore they should better stay away from this stock
at this time.
Cipla, Lupin and Sun Pharma are overvalued stocks. There is moderate risk to enter in these
stocks at this time. For this kind of situation we must select stock which is traded at very high
volume. In this case Sun Pharma is good buying option compared to other two. In case if you
invest in such overvalued stock of growing sector industry; you must actively track the
market to avoid any losses.
Biocon seems to be the only company whose shares are fairly valued by market at this
time.You can Buy and hold Biocon for mid-to-long term as it have huge potential of earnings
in future.
Overall, after doing comparative P/E ratio analysis we can conclude that Pharma Sector
companies are less volatile as compared to Banking Sector stocks. We must ‘Buy Cheap and
Sell when Expensive’ to earn good returns from our investments
36

37. CONCLUSIONS &
RECOMMENDATIONS
37

38. 4) CONCLUSIONS & RECOMMENDATIONS
4.1) CONCLUSIONS:
P/E ratios are not the magical prognostic tool some once thought they were, they can still be
valuable when used in the proper manner.
The P/E multiple shows how much investors are willing to pay per rupee of earnings.
A higher P/E ratio suggests that investors are expecting higher earnings growth in the future
compared to companies with a lower P/E. However, a higher P/E may also indicate
overvaluation Hence, this multiple doesn't tell us the whole story by itself.
The main reason to avoid company stock with high P/E ratios is that it provides you less
opportunity to make profits and more potential for losing money.
It's usually more useful to compare the P/E ratios of one company to other companies in the
same industry, to the market in general or against the company's own historical P/E to come
to a reasonable conclusion about the attractiveness of the stock.
P/E multiples send false signals when we ignore risk and when we don’t properly account for
shareholder value added that is generated by growth.Even if the companies in same industry
have similar PE ratio, the company which have competitive advantage shows higher growth
compared to other. In other words, the P/E multiple offers no means to discriminate among
such companies.
Although the P/E often doesn't tell us much, it can be useful to compare the P/E of one
company to another in the same industry, to the market in general, or to the company's own
historical P/E ratios.
4.2) RECOMMENDATIONS:
Before taking decisions about stocks do comapare the other fundamentals about the company
in the same industry. Along with PE ratio also use PEG ratio, ROE, Competetive advantage
for making final decision.
On long term basis equities have a great potential of earnings. Select companies which are
undervalued yet have strong financial assets, good management and policies, customer base,
product lines and which doesn’t have high debt and liabilities. In case if you are intraday
trader or short term investors you can take calculated risks of depending completely on PE
ratios for decisions about investments in equities.
Buy stocks with FAIR values of PE to avoid risk of unpredictability and volatility of share
market. Avoid running behind herd and buying High PE if you don’t track market at regular
intervals. High PE has high expectations hence book profits at right time and exit before
downward rally starts. Time factor is really important factor when you solely depend on PE
analysis for trading in market.
38

39. LIMITATIONS
39

40. 5) LIMITATIONS
The study on ‘Price per earnings ratio and it’s applications’ has been carried out with
following limitations.
PE ratio doesn’t offer much to institutional investors due to it’s incapability in standalone.
So the study has been more focussed on retail investors.
Banking Sector stocks cover large portion of portfolio of Institutional investors (including
FIIs) and therefore they can’t afford to make decisions solely using PE ratio analysis.
Website Rediff Money used as data source for calculations of PE ratio gives EPS of 12th
March (recently updated)
The ranges of PE values for Interpretations are highly subjective as they change from
Industry to Industry.
40

41. BIBLIOGRAPHY
Books:
Financial Management ……………………………………Ashwath Damodaran
Capital Market ……………………………………………..NCFM module
Websites:
http://www.money.rediff.com
http://www.moneycontrol.com
http://www.managementparadise.com
http://www.investopedia.com
http://www.wikipedia.com
http://www.caclub.com
Blogs:
http://www.ashwamedhfinancialservices.blogspot.com
Ashwamedh Financial Services
Deepak Doddamani
41