Does Prime People Plc’s (AIM:PRP) PE Ratio Warrant A Buy?
Prime People Plc (AIM:PRP) is trading with a trailing P/E of 7.6x, which is lower than the industry average of 17x. 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for PRP
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each pound of the company’s earnings.
P/E Calculation for PRP
Price-Earnings Ratio = Price per share ÷ Earnings per share
PRP Price-Earnings Ratio = £0.94 ÷ £0.124 = 7.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 PRP, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. PRP’s P/E of 7.6x is lower than its industry peers (17x), which implies that each dollar of PRP’s earnings is being undervalued by investors. Therefore, according to this analysis, PRP is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy PRP, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to PRP. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with PRP, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing PRP to are fairly valued by the market. If this does not hold true, PRP’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? 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 PRP 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.
Are you a potential investor? If you are considering investing in PRP, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Prime People for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
