PE is Price to earning ratio.
Industry PE is the average price-to-earning ratio of a particular sector or industry. It’s used as a benchmark to compare the PE of a stock to the PE of an entire industry.
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If the PE of a stock is lower than its industry PE, then it’s considered to be undervalued in comparison to its other peers.
For example, the PE of major banks in India is as follows:
|Kotak Mahindra Bank||37.45|
The way to calculate the industry PE of the banking sector is to take the average PE of all banks.
The average industry PE of the banking sector works out to 25.51 (adding the PE of all banks and dividing it by the number of banks – in our example 6).
This industry PE of 25.51 can now be used to compare against the individual PE of a bank.
HDFC Bank is currently trading at 22.31 PE, which is lower than the industry PE.
ICICI Bank is more expensive than its peers, as it’s quoting a PE higher than the Industry PE.
IndusInd Bank and Bandhan Bank which have significantly fallen in the Coronavirus led global market crash – are currently much cheaper in valuation as compared to other banks in the sector.
- If a stock has lower PE as compared to the industry PE, it does not necessary mean it’s a good company to buy. Many new investors make the mistake of searching for low PE companies. Most of these companies do not perform well in the long run.
- A low PE company could have fundamental issues. In the banking sector, banks with low PE are usually struggling with NPA (non-performing asset) issues. Low PE could also be due to management and various other issues.
- Industry leaders and fast growing companies usually command a higher PE than the industry PE.
Note: PE is dependent on current market price of a share, hence the numbers change everyday. The above numbers are as of 13 March 2020. To keep the example simple, we have taken only 6 banks. There are more banks in the banking sector.