Does Whitehaven Coal Limited’s (ASX:WHC) PE Ratio Warrant A Sell?
I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Whitehaven Coal Limited (ASX:WHC).
Whitehaven Coal Limited (ASX:WHC) is trading with a trailing P/E of 11x, which is higher than the industry average of 10.6x. While WHC might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 Whitehaven Coal
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 WHC
Price-Earnings Ratio = Price per share ÷ Earnings per share
WHC Price-Earnings Ratio = A$5.65 ÷ A$0.514 = 11x
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 WHC, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. WHC’s P/E of 11x is higher than its industry peers (10.6x), which implies that each dollar of WHC’s earnings is being overvalued by investors. As such, our analysis shows that WHC represents an over-priced stock.
A few caveats
However, before you rush out to sell your WHC shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to WHC. 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 WHC, 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 WHC to are fairly valued by the market. If this is violated, WHC’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to WHC. 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 WHC’s future growth? Take a look at our free research report of analyst consensus for WHC’s outlook.
Past Track Record: Has WHC 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 WHC’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.
