I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Eisen- und Hüttenwerke AG (FRA:EIS) is trading with a trailing P/E of 43.7, which is higher than the industry average of 8.5. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 EIS
Price-Earnings Ratio = Price per share ÷ Earnings per share
EIS Price-Earnings Ratio = €21.6 ÷ €0.494 = 43.7x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as EIS, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since EIS’s P/E of 43.7 is higher than its industry peers (8.5), it means that investors are paying more for each dollar of EIS’s earnings. This multiple is a median of profitable companies of 4 Metals and Mining companies in DE including Pasinex Resources, Aurubis and Salzgitter. You could also say that the market is suggesting that EIS is a stronger business than the average comparable company.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to EIS. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where Eisen- und Hüttenwerke AG is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with EIS are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
Since you may have already conducted your due diligence on EIS, the overvaluation of the stock may mean it is a good time to reduce 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:
- Future Outlook: What are well-informed industry analysts predicting for EIS’s future growth? Take a look at our free research report of analyst consensus for EIS’s outlook.
- Past Track Record: Has EIS 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 EIS’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 firstname.lastname@example.org.