In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Marksans Pharma Limited (NSE:MARKSANS) trades with a trailing P/E of 31.9, which is higher than the industry average of 25.5. While this might not seem positive, 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.
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Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 MARKSANS
Price-Earnings Ratio = Price per share ÷ Earnings per share
MARKSANS Price-Earnings Ratio = ₹32.8 ÷ ₹1.029 = 31.9x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 MARKSANS, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 31.9, MARKSANS’s P/E is higher than its industry peers (25.5). This implies that investors are overvaluing each dollar of MARKSANS’s earnings. This multiple is a median of profitable companies of 25 Pharmaceuticals companies in IN including Vasundhara Rasayans, Vivimed Labs and Vivimed Labs. You could also say that the market is suggesting that MARKSANS is a stronger business than the average comparable company.
Assumptions to watch out for
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to MARKSANS. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Marksans Pharma Limited is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to MARKSANS may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
Since you may have already conducted your due diligence on MARKSANS, 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: