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Is Mears Group plc (LSE:MER) A Buy At Its Current Price?

Mears Group plc (LSE:MER) is currently trading at a trailing P/E of 21.5x, which is lower than the industry average of 19.6x. While MER might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for MER

Breaking down the P/E ratio

LSE:MER PE PEG Gauge Sep 19th 17
LSE:MER PE PEG Gauge Sep 19th 17

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.

Formula

Price-Earnings Ratio = Price per share ÷ Earnings per share

P/E Calculation for MER

Price per share = 4.48

Earnings per share = 0.208

∴ Price-Earnings Ratio = 4.48 ÷ 0.208 = 21.5x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to MER, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use below. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.

At 21.5x, MER’s P/E is higher than its industry peers (19.6x). This implies that investors are overvaluing each dollar of MER’s earnings. As such, our analysis shows that MER represents an over-priced stock.

Assumptions to be aware of

Before you jump to the conclusion that MER represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to MER. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with MER, then MER’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with MER, MER’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing MER to are fairly valued by the market. If this assumption is violated, MER's P/E may be lower than its peers because its peers are actually overvalued by investors.

LSE:MER Future Profit Sep 19th 17
LSE:MER Future Profit Sep 19th 17

What this means for you:

Are you a shareholder? Since you may have already conducted your due diligence on MER, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I've outlined above.

Are you a potential investor? If you are considering investing in MER, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.

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 Mears Group 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.

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