Exillon Energy plc (LSE:EXI) is trading with a trailing P/E of 3.5x, which is lower than the industry average of 19x. 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. 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. View our latest analysis for Exillon Energy
What you need to know about the P/E 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 EXI
Price-Earnings Ratio = Price per share ÷ Earnings per share
EXI Price-Earnings Ratio = $1.04 ÷ $0.297 = 3.5x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as EXI, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 3.5x, EXI’s P/E is lower than its industry peers (19x). This implies that investors are undervaluing each dollar of EXI’s earnings. Therefore, according to this analysis, EXI is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy EXI immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to EXI, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with EXI, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing EXI to are fairly valued by the market. If this does not hold true, EXI’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on EXI, 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 EXI’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 EXI 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 EXI’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.