Is Patisserie Holdings plc’s (LON:CAKE) PE Ratio A Signal To Sell For Investors?
Patisserie Holdings plc (AIM:CAKE) is trading with a trailing P/E of 26.2x, which is higher than the industry average of 19.2x. While this makes CAKE appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Patisserie Holdings
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for relative valuation. 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 CAKE
Price-Earnings Ratio = Price per share ÷ Earnings per share
CAKE Price-Earnings Ratio = £4.56 ÷ £0.174 = 26.2x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CAKE, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 26.2x, CAKE’s P/E is higher than its industry peers (19.2x). This implies that investors are overvaluing each dollar of CAKE’s earnings. Therefore, according to this analysis, CAKE is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your CAKE shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to CAKE, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with CAKE, 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 CAKE to are fairly valued by the market. If this does not hold, there is a possibility that CAKE’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on CAKE, the overvaluation of the stock may mean it is a good time to reduce 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 CAKE’s future growth? Take a look at our free research report of analyst consensus for CAKE’s outlook.
Past Track Record: Has CAKE 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 CAKE’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.
