Olin Corporation (NYSE:OLN) trades with a trailing P/E of 76.9x, which is higher than the industry average of 21.2x. 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Olin
Demystifying 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 OLN
Price-Earnings Ratio = Price per share ÷ Earnings per share
OLN Price-Earnings Ratio = $36.06 ÷ $0.469 = 76.9x
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 OLN, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. OLN’s P/E of 76.9x is higher than its industry peers (21.2x), which implies that each dollar of OLN’s earnings is being overvalued by investors. Therefore, according to this analysis, OLN is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that OLN should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to OLN, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with OLN, 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 OLN to are fairly valued by the market. If this is violated, OLN’s P/E may be lower than its peers as they are actually overvalued by investors.
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.