I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.

The Karur Vysya Bank Limited (NSE:KARURVYSYA) trades with a trailing P/E of 30.1, which is higher than the industry average of 21.6. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. 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 Karur Vysya Bank

Breaking down the Price-Earnings ratio

P/E is a popular ratio used for relative valuation. 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 KARURVYSYA

Price-Earnings Ratio = Price per share ÷ Earnings per share

KARURVYSYA Price-Earnings Ratio = ₹92.3 ÷ ₹3.067 = 30.1x

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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as KARURVYSYA, 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. At 30.1, KARURVYSYA’s P/E is higher than its industry peers (21.6). This implies that investors are overvaluing each dollar of KARURVYSYA’s earnings. This multiple is a median of profitable companies of 18 Banks companies in IN including Karnataka Bank, Vijaya Bank and South Indian Bank. You could think of it like this: the market is pricing KARURVYSYA as if it is a stronger company than the average of its industry group.

Assumptions to watch out for

Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to KARURVYSYA. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where The Karur Vysya Bank Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with KARURVYSYA are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.