The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Kingfisher plc (LON:KGF) is currently trading at a trailing P/E of 13.2, which is higher than the industry average of 10.5. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
What you need to know about 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 KGF
Price-Earnings Ratio = Price per share ÷ Earnings per share
KGF Price-Earnings Ratio = £2.43 ÷ £0.185 = 13.2x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to KGF, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since KGF’s P/E of 13.2 is higher than its industry peers (10.5), it means that investors are paying more for each dollar of KGF’s earnings. This multiple is a median of profitable companies of 24 Specialty Retail companies in GB including United Carpets Group, Cambria Automobiles and Bonmarché Holdings. You could also say that the market is suggesting that KGF is a stronger business than the average comparable company.
Assumptions to watch out for
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to KGF. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Kingfisher plc is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to KGF may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
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 KGF. 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 KGF’s future growth? Take a look at our free research report of analyst consensus for KGF’s outlook.
- Past Track Record: Has KGF 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 KGF’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 email@example.com.