Hexaware Technologies Limited (NSEI:HEXAWARE) trades with a trailing P/E of 21.8x, which is higher than the industry average of 18.9x. While HEXAWARE 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Hexaware Technologies
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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.
P/E Calculation for HEXAWARE
Price-Earnings Ratio = Price per share ÷ Earnings per share
HEXAWARE Price-Earnings Ratio = ₹363.85 ÷ ₹16.721 = 21.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to HEXAWARE, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. HEXAWARE’s P/E of 21.8x is higher than its industry peers (18.9x), which implies that each dollar of HEXAWARE’s earnings is being overvalued by investors. As such, our analysis shows that HEXAWARE represents an over-priced stock.
A few caveats
However, before you rush out to sell your HEXAWARE 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 HEXAWARE, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with HEXAWARE, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing HEXAWARE to are fairly valued by the market. If this does not hold true, HEXAWARE’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on HEXAWARE, 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.