Ten Entertainment Group Plc (LSE:TEG) is trading with a trailing P/E of 1.7x, which is lower than the industry average of 22.3x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for TEG
Breaking down the Price-Earnings 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 pound of the company’s earnings.
P/E Calculation for TEG
Price-Earnings Ratio = Price per share ÷ Earnings per share
TEG Price-Earnings Ratio = 2.04 ÷ 1.204 = 1.7x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to TEG, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since TEG’s P/E of 1.7x is lower than its industry peers (22.3x), it means that investors are paying less than they should for each dollar of TEG’s earnings. As such, our analysis shows that TEG represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy TEG immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to TEG, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with TEG, 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 TEG to are fairly valued by the market. If this does not hold true, TEG’s lower P/E ratio may be because firms in our peer group are 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 TEG. 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 TEG, 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 Ten Entertainment 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.