At $20.17, Is Barrick Gold Corporation (TSX:ABX) A Buy?
Barrick Gold Corporation (TSX:ABX) is trading with a trailing P/E of 8x, which is lower than the industry average of 10.4x. While this makes ABX 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Barrick Gold
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. 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 dollar of the company’s earnings.
P/E Calculation for ABX
Price-Earnings Ratio = Price per share ÷ Earnings per share
ABX Price-Earnings Ratio = 20.17 ÷ 2.027 = 8x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ABX, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since ABX's P/E of 8x is lower than its industry peers (10.4x), it means that investors are paying less than they should for each dollar of ABX's earnings. As such, our analysis shows that ABX represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy ABX immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ABX, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with ABX, 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 ABX to are fairly valued by the market. If this does not hold, there is a possibility that ABX’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on ABX, 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 you are considering investing in ABX, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 Barrick Gold 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.
