Argo Group Limited (AIM:ARGO) is trading with a trailing P/E of 2.5x, which is lower than the industry average of 15.2x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Argo Group
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 pound of the company’s earnings.
P/E Calculation for ARGO
Price-Earnings Ratio = Price per share ÷ Earnings per share
ARGO Price-Earnings Ratio = $0.24 ÷ $0.096 = 2.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 ARGO, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. ARGO’s P/E of 2.5x is lower than its industry peers (15.2x), which implies that each dollar of ARGO’s earnings is being undervalued by investors. As such, our analysis shows that ARGO represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy ARGO immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to ARGO. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with ARGO, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing ARGO to are fairly valued by the market. If this does not hold, there is a possibility that ARGO’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on ARGO, 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. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is ARGO’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has ARGO been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of ARGO’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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.