I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Exmar NV (EBR:EXM) is currently trading at a trailing P/E of 7.5x, which is lower than the industry average of 13.8x. While EXM might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for 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 EXM
Price-Earnings Ratio = Price per share ÷ Earnings per share
EXM Price-Earnings Ratio = $7.06 ÷ $0.941 = 7.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to EXM, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. EXM’s P/E of 7.5x is lower than its industry peers (13.8x), which implies that each dollar of EXM’s earnings is being undervalued by investors. Since the Oil and Gas sector in BE is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as Eni, Fluxys Belgium and . As such, our analysis shows that EXM represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy EXM immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to EXM. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with EXM, 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 EXM to are fairly valued by the market. If this is violated, EXM’s P/E may be lower than its peers as they are actually overvalued by investors.
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 add more of EXM to your portfolio. 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 EXM’s future growth? Take a look at our free research report of analyst consensus for EXM’s outlook.
- Past Track Record: Has EXM 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 EXM’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.