Deepak Doddamani

TABLE OF CONTENTS 1) INTRODUCTION

1.1) OBJECTIVES OF STUDY 1.1.1) PRIMARY OBJECTIVES 1.1.2) SECONDARY OBJECTIVES 1.2) NEED FOR STUDY 1.3) SCOPE OF THE STUDY 1.4) REASEARCH METHODOLOGY 1.4.1) TYPE OF RESEARCH 1.4.2) SOURCE OF DATA 1.4.3) TOOLS FOR ANALYSIS 1.5) BASIS FOR SELECTION OF COMPANIES

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2) BACKGROUND
2.1) STRUCTURE OF BANKING INDUSTRY IN INDIA 2.2) LIST OF BANKS IN INDIA 2.2.1) Central Bank in India 2.2.2) Nationalized Banks 2.2.3) Old Private Sector Banks/Societies 2.2.4) New private sector banks 2.3) Banking Sector companies under study: 2.3.1) State Bank of India (SBI) 2.3.2) HDFC Bank 2.3.3) ICICI Bank 2.3.4) Punjab National Bank (PNB) 2.3.5) Canara Bank 2.4) OTHER DATA ABOUT BANKING SECTOR 2.5) Life Science companies 2.5.1) Pharmaceutical industry in India 2.5.2) Top 20 Pharma Companies in Life Sciences category in India : 2.6) Life Science Companies under study: 2.6.1) Ranbaxy Laboratories Limited 2.6.2) Cipla Limited : 2.6.3) Lupin Ltd 2.6.4) Sun Pharmaceutical Industries 2.6.5) Wockhardt Ltd

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7 8 8 8 9 9 10 10 10 10 10 10 11 12 12 12 13 13 13 13 13 13

2.6.6) Biocon Limited

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3) METHODOLOGY
3.1) LITERATURE REVIEW 3.1.1) INVESTMENT 3.1.2) ANALYSIS OF STOCKS 3.1.3) FUNDAMENTAL ANALYSIS 3.1.4) FINANCIAL RATIOS 3.1.5) WHAT IS P/E RATIO ? 3.1.6) FACTORS WHICH INFLUENCE THE PRICE/EARNINGS RATIO 3.1.7) Components of PE Ratio 3.1.8) Types of EPS 3.1.9) GROWTH OF EARNINGS 3.1.10) HOW TO INTERPRET P/E RATIO? 3.1.11) Concepts related to P/E 3.1.12) PROBLEMS WITH P/E RATIO 3.1.13) P/E ratios in India during 1990 and 2005 3.1.14) APPLICATIONS OF PE ratio 3.2) DATA & OBSERVATIONS 3.2.1) PE Ratios of Banking Sector Stocks 3.2.2) Determination of P/E values of Banks. 3.2.3) Determination of P/E ratio values of Life Science companies: 3.3) ANALYSIS and INTERPRETATIONS 3.3.1) DATA ANALYSIS & INTERPRETATIONS of BANKING SECTOR STOCK: 3.3.2) DATA ANALYSIS & INTERPRETATIONS of LIFE SCIENCES SECTOR STOCKS: 3.4) SUGGESTIONS:

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15 15 16 17 18 19 19 20 21 23 24 25 26 27 28 29 29 31 32 33 34 34 35

4) CONCLUSIONS & RECOMMENDATIONS

4.1) CONCLUSIONS: 4.2) RECOMMENDATIONS:

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5) LIMITATIONS

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BIBLIOGRAPHY

INTRODUCTION

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.
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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.

BACKGROUND

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.

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

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

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.

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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:

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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 2) Ranbaxy 3) Dr. Reddys lab 4) Lupin Ltd. 5) Aurobindo Pharma 6) Dabur 7) Sun Pharma 8) Cadilla Healthcare 9) Jubiliant LifeScience 10) Piramal Heathcare

11) GlaxoSmithKline Pharma 12) Ipca Pharma 13) Wockhardt 14) Torrent Pharma 15) Sterling Bio 16) Biocon 17) Orchid Chemicals 18) Alembic 19) Aventis Pharma 20) Glenmark Pharma

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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.

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METHODOLOGY

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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.

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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.

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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

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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
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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
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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.

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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.

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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.

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EPS & Extraordinary items An item included in a companys 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.
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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 doesnt 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.

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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 companys 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.

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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 doesnt 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 dont 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 doesnt always translate into high P/E ratios. Firms with similar growth rate often dont sell at same P/E ratio Market determines value on long term expectations rather than short term performance.

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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 BSE100 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).

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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 firms 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 companys 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.
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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 (Rs.)

EPS (Rs.)

PE Value (Ratio)

PUBLIC SECTOR BANKS State Bank of India 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 2150. 25 137.05 113.40 694.10 348.10 51.10 412.65 80.45 438.60 96.35 90.45 174.95 89.45 241.45 769.45 69.25 101.30 174.46 37.33 24.03 121.42 46.60 7.31 74.10 7.24 101.67 22.94 15.89 40.65 13.18 39.13 144.00 19.27 21.82 12.74 3.85 4.82 5.92 7.65 7.42 5.83 11.24 4.32 4.35 5.87 4.38 6.71 6.24 5.65 3.72 4.69

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Uco Bank United Bank of India Union Bank of India Vijaya Bank OLD PRIVATE SECTOR BANKS City Union Bank Dhanalaxmi Bank Federal Bank Jammu and Kashmir Bank Karnataka Bank Karur Vysya Bank South Indian Bank NEW PRIVATE SECTOR BANKS Axis Bank HDFC Bank ICICI Bank IndusInd Bank ING Vysya Bank Kotak Mahindra Bank Yes Bank DCB Bank

78.10 63.80 208.00 58.00

16.68 17.52 27.01 11.72

4.76 3.88 7.89 5.05

48.65 54.25 421.80 912.15 86.40 417.10 23.60

6.87 -13.58 45.41 165.65 13.07 46.81 3.54

7.21 - 4.09 9.44 5.54 6.29 8.81 6.70

1013.05 534.40 818.85 314.40 331.40 568.20 332.05 40.55

102.67 22.02 56.08 17.16 30.40 14.65 27.68 18.07

10.19 24.65 15.14 18.74 11.14 39.89 12.50 2.32

Note: CMP = Current Market Price EPS = Earnings Per Share

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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

Days High (Rs.)

Days Low (Rs.)

Average Market Price (Rs.)

Earnings PE per Ratio share (Value) (EPS) (Rs.)

1 2 3 4 5 6

State Bank of India (SBI) HDFC Bank ICICI Bank Punjab National Bank (PNB) Canara Bank Axis Bank

2189.85 2147.00 549.70 855.55 795.00 425.20 534.95 823.15 772.55 411.10

2168.42 542.32 839.35 758.77 418.15 1024.17

174.46 22.02 56.08 144.00 74.10 102.67

12.42 24.62 14.96 5.27 5.64 9.97

1038.35 1010.00

Bar Chart Representation of Above data:

25 20 15 10 5 0 SBI HDFC ICICI PNB CANARA AXIS PE Value

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3.2.3) Determination of P/E ratio values of Life Science companies:

Days High-Low prices of the stocks and EPS are used to calculate PE values of below Life Science companies on 15th June 2012.

Company

Days High (Rs.)

Days Low (Rs.) 471.10 304.00 505.10 583.70 827.45 216.70

Average (Rs.) 475.9 307.37 511.55 590.1 841.82 219.35

EPS (Rs.) -72.32 14.00 18.01 18.62 16.81 12.78

PE Value (Ratio) - 6.58 21.95 28.40 31.69 50.07 17.16

Ranbaxy Cipla Lupin Sun Pharma Wockhardt Biocon

480.70 310.75 518.00 596.50 856.20 222.00

Bar chart representation of above data:

60 50 40 30 20 10 0 -10 Ranbaxy Cipla Lupin Sun Pharma Wockhardt Biocon PE Value

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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.

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3.3.1) DATA ANALYSIS & INTERPRETATIONS of BANKING SECTOR STOCK:

Bank Name

PE Value

Analysis PE Value is FAIR HIGH FAIR LOW LOW FAIR

Interpretation

SBI HDFC ICICI PNB CANARA AXIS

12.42 24.62 14.96 5.27 5.64 9.97

Rightly Valued Overvalued Rightly Valued Undervalued Undervalued Rightly Valued

3.3.2) DATA ANALYSIS & INTERPRETATIONS of LIFE SCIENCES SECTOR STOCKS:

Pharma Company Name Ranbaxy Cipla Lupin Sun Pharma Wockhardt Biocon

PE Value

Analysis PE Value is

Interpretation

-6.58 21.95 28.40 31.69 50.07 17.16

UNDEFINED HIGH HIGH HIGH VERY HIGH FAIR

Undervalued / Avoided Overvalued Overvalued Overvalued Highly Overvalued Rightly Valued

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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.

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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. dont 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. Its 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 doesnt 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

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CONCLUSIONS & RECOMMENDATIONS

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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 dont 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 doesnt 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 dont 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.
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LIMITATIONS

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5) LIMITATIONS
The study on Price per earnings ratio and its applications has been carried out with following limitations. PE ratio doesnt offer much to institutional investors due to its 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 cant 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.

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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
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