Does Smith & Nephew plc’s (LON:SN.) PE Ratio Warrant A Buy?
Smith & Nephew plc (LSE:SN.) trades with a trailing P/E of 21.7x, which is lower than the industry average of 29.6x. While this makes SN. 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 explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Smith & Nephew
What you need to know about the P/E 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 pound of the company’s earnings.
P/E Calculation for SN.
Price-Earnings Ratio = Price per share ÷ Earnings per share
SN. Price-Earnings Ratio = $19.04 ÷ $0.878 = 21.7x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SN., such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 21.7x, SN.’s P/E is lower than its industry peers (29.6x). This implies that investors are undervaluing each dollar of SN.’s earnings. Therefore, according to this analysis, SN. is an under-priced stock.
A few caveats
Before you jump to the conclusion that SN. is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to SN., or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with SN., 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 SN. to are fairly valued by the market. If this does not hold true, SN.’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to SN.. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 SN.’s future growth? Take a look at our free research report of analyst consensus for SN.’s outlook.
Past Track Record: Has SN. 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 SN.’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.
