SBI Life Insurance Company Limited (NSEI:SBILIFE) trades with a trailing P/E of 63.3x, which is higher than the industry average of 42x. While SBILIFE 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for SBI Life Insurance
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 SBILIFE
Price-Earnings Ratio = Price per share ÷ Earnings per share
SBILIFE Price-Earnings Ratio = ₹718.55 ÷ ₹11.356 = 63.3x
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 SBILIFE, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 63.3x, SBILIFE’s P/E is higher than its industry peers (42x). This implies that investors are overvaluing each dollar of SBILIFE’s earnings. Therefore, according to this analysis, SBILIFE is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your SBILIFE shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to SBILIFE, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with SBILIFE, 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 SBILIFE to are fairly valued by the market. If this does not hold true, SBILIFE’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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.