At $3.48, Is Telstra Corporation Limited (ASX:TLS) A Buy?
Telstra Corporation Limited (ASX:TLS) is currently trading at a trailing P/E of 10.7x, which is lower than the industry average of 18.8x. While TLS might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Telstra
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 TLS
Price-Earnings Ratio = Price per share ÷ Earnings per share
TLS Price-Earnings Ratio = 3.48 ÷ 0.325 = 10.7x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as TLS, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 10.7x, TLS’s P/E is lower than its industry peers (18.8x). This implies that investors are undervaluing each dollar of TLS’s earnings. Therefore, according to this analysis, TLS is an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that TLS is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to TLS, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with TLS, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing TLS to are fairly valued by the market. If this does not hold, there is a possibility that TLS’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to TLS. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If you are considering investing in TLS, 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 Telstra 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.
