In This Article:
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Dr Reddy’s Laboratories Limited (NSE:DRREDDY) is trading with a trailing P/E of 28.9, which is higher than the industry average of 20.5. 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for Dr. Reddy’s Laboratories
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 DRREDDY
Price-Earnings Ratio = Price per share ÷ Earnings per share
DRREDDY Price-Earnings Ratio = ₹2401 ÷ ₹83.012 = 28.9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to DRREDDY, 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. Since DRREDDY’s P/E of 28.9 is higher than its industry peers (20.5), it means that investors are paying more for each dollar of DRREDDY’s earnings. This multiple is a median of profitable companies of 25 Pharmaceuticals companies in IN including Vasundhara Rasayans, Vivimed Labs and Beryl Drugs. You could also say that the market is suggesting that DRREDDY is a stronger business than the average comparable company.
A few caveats
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 DRREDDY. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where Dr Reddy’s Laboratories 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. We should also be aware that the stocks we are comparing to DRREDDY may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.