Is Forterra plc’s (LSE:FORT) PE Ratio A Signal To Buy For Investors?
Forterra plc (LSE:FORT) trades with a trailing P/E of 12.9x, which is lower than the industry average of 21.2x. 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 explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Forterra
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 pound of the company’s earnings.
P/E Calculation for FORT
Price-Earnings Ratio = Price per share ÷ Earnings per share
FORT Price-Earnings Ratio = 2.82 ÷ 0.219 = 12.9x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to FORT, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. FORT’s P/E of 12.9x is lower than its industry peers (21.2x), which implies that each dollar of FORT’s earnings is being undervalued by investors. As such, our analysis shows that FORT represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy FORT immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to FORT. 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 FORT, 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 FORT to are fairly valued by the market. If this is violated, FORT’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? 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 FORT 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.
Are you a potential investor? If you are considering investing in FORT, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 Forterra 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.
