I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Sogeclair SA (EPA:SOG) trades with a trailing P/E of 15.2x, which is lower than the industry average of 23.6x. While SOG 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down 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 dollar of the company’s earnings.
P/E Calculation for SOG
Price-Earnings Ratio = Price per share ÷ Earnings per share
SOG Price-Earnings Ratio = €25.4 ÷ €1.672 = 15.2x
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 SOG, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since SOG’s P/E of 15.2 is lower than its industry peers (23.6), it means that investors are paying less for each dollar of SOG’s earnings. This multiple is a median of profitable companies of 7 Aerospace & Defense companies in FR including Figeac Aero Société Anonyme, Lisi and Safran. One could put it like this: the market is pricing SOG as if it is a weaker company than the average company in its industry.
A few caveats
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to SOG. 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 SOG, 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 SOG to are fairly valued by the market. If this is violated, SOG’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on SOG, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 SOG’s future growth? Take a look at our free research report of analyst consensus for SOG’s outlook.
- Past Track Record: Has SOG 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 SOG’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.