Should You Buy Standard Life Investments Property Income Trust Limited (LSE:SLI) At This PE Ratio?
Standard Life Investments Property Income Trust Limited (LSE:SLI) is currently trading at a trailing P/E of 14.8x, which is lower than the industry average of 25.5x. While this makes SLI appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 Standard Life Investments Property Income Trust
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 pound of the company’s earnings.
Formula
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for SLI
Price per share = 0.9
Earnings per share = 0.061
∴ Price-Earnings Ratio = 0.9 ÷ 0.061 = 14.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to SLI, 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. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
At 14.8x, SLI’s P/E is lower than its industry peers (25.5x). This implies that investors are undervaluing each dollar of SLI’s earnings. Therefore, according to this analysis, SLI is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy SLI immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to SLI. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with SLI, then investors would naturally value SLI at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with SLI, investors would also value SLI at a lower price since it is a lower growth investment. Both scenarios would explain why SLI has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing SLI to are fairly valued by the market. If this does not hold, there is a possibility that SLI’s P/E is lower because firms in our peer group are being 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 SLI. 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 SLI 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 Standard Life Investments Property Income Trust 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.
