This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Danieli & C Officine Meccaniche SpA (BIT:DAN) is trading with a trailing P/E of 46.5, which is higher than the industry average of 24.9. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 DAN
Price-Earnings Ratio = Price per share ÷ Earnings per share
DAN Price-Earnings Ratio = €20.75 ÷ €0.446 = 46.5x
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 DAN, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. DAN’s P/E of 46.5 is higher than its industry peers (24.9), which implies that each dollar of DAN’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 11 Machinery companies in IT including Prima Industrie, SITI – B&T Group and Interpump Group. You could think of it like this: the market is pricing DAN as if it is a stronger company than the average of its industry group.
A few caveats
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to DAN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Danieli & C Officine Meccaniche SpA is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to DAN may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in DAN. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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:
- Future Outlook: What are well-informed industry analysts predicting for DAN’s future growth? Take a look at our free research report of analyst consensus for DAN’s outlook.
- Past Track Record: Has DAN 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 DAN’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 past 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. For errors that warrant correction please contact the editor at email@example.com.