At £2.11, Is Good Energy Group PLC (AIM:GOOD) A Buy?
Good Energy Group PLC (AIM:GOOD) is currently trading at a trailing P/E of 28.2x, which is lower than the industry average of 41x. While this makes GOOD appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Good Energy Group
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 pound of the company’s earnings.
P/E Calculation for GOOD
Price-Earnings Ratio = Price per share ÷ Earnings per share
GOOD Price-Earnings Ratio = 2.11 ÷ 0.075 = 28.2x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to GOOD, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since GOOD's P/E of 28.2x is lower than its industry peers (41x), it means that investors are paying less than they should for each dollar of GOOD's earnings. Therefore, according to this analysis, GOOD is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy GOOD immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to GOOD. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with GOOD, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing GOOD to are fairly valued by the market. If this is violated, GOOD's P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on GOOD, the undervaluation of the stock may mean it is a good time to top up on 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.
Are you a potential investor? If GOOD has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Good Energy Group for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
