The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
ING Groep NV (AMS:INGA) trades with a trailing P/E of 10.2x, which is lower than the industry average of 11.8x. While INGA 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Breaking down the Price-Earnings 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 INGA
Price-Earnings Ratio = Price per share ÷ Earnings per share
INGA Price-Earnings Ratio = €13.06 ÷ €1.284 = 10.2x
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 INGA, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. INGA’s P/E of 10.2x is lower than its industry peers (14.6x), which implies that each dollar of INGA’s earnings is being undervalued by investors. Since the Banks sector in NL 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 NIBC Holding, ABN AMRO Group and Van Lanschot Kempen. Therefore, according to this analysis, INGA is an under-priced stock.
A few caveats
However, before you rush out to buy INGA, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to INGA. 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 INGA, 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 INGA to are fairly valued by the market. If this does not hold, there is a possibility that INGA’s P/E is lower because our peer group is overvalued by the market.
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 INGA 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for INGA’s future growth? Take a look at our free research report of analyst consensus for INGA’s outlook.
- Past Track Record: Has INGA 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 INGA’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.