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Standalone vs Consolidated PE Ratio - Impact of Financial Results

HomeStandalone vs Consolidated PE Ratio – Impact of Financial Results

The Price Earnings ratio (PE Ratio) is one of the most basic and widely used ratio for valuing companies where the price of a company’s share listed on an exchange is divided by its reported Earnings Per Share (“EPS“). The PE Ratio thus derived is compared with the industry PE Ratio to determine if there is potential upside or if the share is overvalued, undervalued or fairly valued. Simply put, PE Ratio indicates how much the market is willing to pay today, to get each rupee (or each $) of the future earnings of the company.

For more on PE Ratio, Also see: Price to Earning Ratio

A lot of investors use the PE ratio figure presented on many websites without looking into its calculation methodology. Keep in mind that on most of the finance portals, the calculation methodology is wrong (on almost all the finance portals we looked at – check the one you refer to).

PE Ratio is arrived at by dividing the current market price of the share by its EPS. The problem lies in the financial results considered for earnings calculation.

Companies can choose to report either Standalone or Consolidated financial results for every quarter ending; Consolidated results must be reported only annually. Consolidated results take into account the performance of subsidiaries and the share of minorities and associate companies. This in many cases has a huge impact on the performance of the Consolidated entity. As an investor, when you buy a share, the intention is to profit also from the revenue which will be generated by the subsidiaries and associates. This is extremely relevant today since companies are increasingly setting up subsidiaries to diversify into new verticals. There are many examples where the parent company is in fact making losses yet on a consolidated basis the entity is profitable. Further, in case of any large diversified company such as Jindal Steel, Tata Motors, or Grasim Industries, the subsidiaries will contribute substantially to the overall performance of the consolidated entity.

In case of such large and diversified companies only consolidated financial results will present a complete picture of the financial position and as such, it will be wrong to calculate the PE ratio using only the standalone financial results.

To explain this with a couple of examples, it would be unreasonable to invest in Tata Steel, while ignoring Corus. Similarly, Tata Motors on a standalone basis will look a very different entity than when you factor in the performance of Jaguar Land Rover. Look at the figures below:

For the Third Quarter (Q3) of 2013

Tata Motors Net Profit/ (Loss) (Standalone): Rs. (458.49) cr.

Tata Motors Net Profit/ (Loss) (Consolidated): Rs. 1,627.50 cr.

Similarly,

Tata Steel Net Profit/ (Loss) (Standalone): Rs. 1,046.39 cr.

Tata Steel Net Profit/ (Loss) (Consolidated): Rs. (763.06) cr.

Sterlite Industries (India) Limited Net Profit/ (Loss) (Standalone): Rs. 541.84 cr.

Sterlite Industries (India) Limited Net Profit/ (Loss) (Consolidated): Rs. 1,191.41 cr.

If the subsidiaries are profitable, the consolidated EPS will be higher and vice-versa. This will have a huge impact on the P/E Multiple of the company. Below table illustrates the impact of this on P/E calculation:

If the subsidiaries are profitable, the consolidated EPS will be higher and vice-versa. This will have a huge impact on the P/E Multiple of the company. Below table illustrates the impact of this on P/E calculation:

Consolidated PE Ratio

On a standalone basis, Tata Motors Limited is trading at a P/E Multiple of 81.46 x, making it a ridiculously expensive stock (i.e. overvalued). However, on consolidated basis, it trades at a P/E Multiple of 8.03 x (this takes into account the Jaguar Land Rover earnings), making it cheap (i.e. undervalued).

Why do many portals report P/E on standalone basis? Frankly, I don’t know, but it is wrong.

My best guess is that this is done just to maintain consistency since some companies choose to report consolidated financial results while others reportstandalone results, on quarterly basis (this is in line with SEBI Rules – as companies can chose their reporting and disclosure standard). Most finance portals are programmed to pick up standalone earnings from all tables which is what results in this inaccuracy.

There are many companies like Tata Motors, State Bank of India, Tata Power etc which report quarterly consolidated financial results but others like ONGC,Hindalco, and Maruti Suzuki etc choose not to reveal consolidated financial results until the end of the financial year. Further, there are companies which operate with no subsidiaries like Hero MotoCorp Limited, Ashok Leyland, Colgate-Palmolive (India) Limited etc, so their earnings will naturally be on standalone basis. What is important is to report correctly for each of them based on their structure.

Index Wide PE calculation – Sensex and Nifty PE 

Similarly, there is a flaw in the way in which the PE Ratio of indexes is calculated. The methodology used for calculating the PE Ratio of indexes (such as the S&P BSE Sensex and the CNX Nifty) is:

A.   To add up the earnings of all the companies in the index to get total earnings.

B.   Calculate total market capitalization — this is done by adding up each index company’s market capitalization (arrived at by multiplying each company’s total shares by its share price).

C.   Finally, dividing (B) by (A) i.e. total market capitalization by total earnings.

Clearly, the total earnings in this case are the earnings generated by the parent company (i.e. on the basis of standalone financial results), while in reality, investors pay for the future earnings of the entity as a whole.

So Much for consistency.

About the Author

Rajat Sharma pictureRajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.