OceanaGold Corporation (TSX:OGC) is trading with a trailing P/E of 8.6x, which is lower than the industry average of 10.2x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for OceanaGold
Breaking down 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. 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 OGC
Price-Earnings Ratio = Price per share ÷ Earnings per share
OGC Price-Earnings Ratio = $2.53 ÷ $0.293 = 8.6x
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 OGC, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 8.6x, OGC’s P/E is lower than its industry peers (10.2x). This implies that investors are undervaluing each dollar of OGC’s earnings. As such, our analysis shows that OGC represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy OGC immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to OGC, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with OGC, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing OGC to are fairly valued by the market. If this is violated, OGC’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on OGC, 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. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for OGC’s future growth? Take a look at our free research report of analyst consensus for OGC’s outlook.
- Past Track Record: Has OGC 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 OGC’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.