Is Greggs plc’s (LSE:GRG) PE Ratio A Signal To Sell For Investors?
Greggs plc (LSE:GRG) is trading with a trailing P/E of 23.5x, which is higher than the industry average of 21.5x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, 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 Greggs
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 pound of the company’s earnings.
P/E Calculation for GRG
Price-Earnings Ratio = Price per share ÷ Earnings per share
GRG Price-Earnings Ratio = 12.5 ÷ 0.531 = 23.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to GRG, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since GRG's P/E of 23.5x is higher than its industry peers (21.5x), it means that investors are paying more than they should for each dollar of GRG's earnings. As such, our analysis shows that GRG represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your GRG shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to GRG, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with GRG, 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 GRG to are fairly valued by the market. If this does not hold, there is a possibility that GRG’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 overvaluation could signal a potential selling opportunity to reduce your exposure to GRG. 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 GRG 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 Greggs 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.
