ED Invest Spólka Akcyjna (WSE:EDI) is trading with a trailing P/E of 7x, which is lower than the industry average of 7.9x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. 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. Check out our latest analysis for ED Invest Spólka Akcyjna
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 dollar of the company’s earnings.
P/E Calculation for EDI
Price-Earnings Ratio = Price per share ÷ Earnings per share
EDI Price-Earnings Ratio = PLN2 ÷ PLN0.287 = 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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as EDI, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. EDI’s P/E of 7x is lower than its industry peers (7.9x), which implies that each dollar of EDI’s earnings is being undervalued by investors. Therefore, according to this analysis, EDI is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy EDI, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to EDI. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with EDI, 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 EDI to are fairly valued by the market. If this is violated, EDI’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of EDI to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 highly recommend you to complete your research by taking a look at the following:
Financial Health: Is EDI’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
Past Track Record: Has EDI 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 EDI’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.