Does Trade Me Group Limited’s (NZSE:TME) PE Ratio Signal A Buying Opportunity?
Trade Me Group Limited (NZSE:TME) trades with a trailing P/E of 18.5x, which is lower than the industry average of 27.6x. While this makes TME appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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. See our latest analysis for TME
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. 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 TME
Price-Earnings Ratio = Price per share ÷ Earnings per share
TME Price-Earnings Ratio = 4.39 ÷ 0.238 = 18.5x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to TME, 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. TME’s P/E of 18.5x is lower than its industry peers (27.6x), which implies that each dollar of TME’s earnings is being undervalued by investors. As such, our analysis shows that TME represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy TME, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to TME. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with TME, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing TME to are fairly valued by the market. If this does not hold, there is a possibility that TME’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? 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 TME. 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.
Are you a potential investor? If TME has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
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 Trade Me Group 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.
