Does RWE Aktiengesellschaft’s (FRA:RWE) PE Ratio Signal A Buying Opportunity?
RWE Aktiengesellschaft (DB:RWE) is trading with a trailing P/E of 6.5x, which is lower than the industry average of 17.2x. While this makes RWE appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, 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 RWE
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 dollar of the company’s earnings.
P/E Calculation for RWE
Price-Earnings Ratio = Price per share ÷ Earnings per share
RWE Price-Earnings Ratio = €20.17 ÷ €3.091 = 6.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as RWE, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since RWE’s P/E of 6.5x is lower than its industry peers (17.2x), it means that investors are paying less than they should for each dollar of RWE’s earnings. As such, our analysis shows that RWE represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy RWE immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to RWE. 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 RWE, 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 RWE to are fairly valued by the market. If this does not hold, there is a possibility that RWE’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 RWE 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 RWE’s future growth? Take a look at our free research report of analyst consensus for RWE’s outlook.
Past Track Record: Has RWE 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 RWE’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.
