Prudential plc (LSE:PRU) is currently trading at a trailing P/E of 17.1x, which is higher than the industry average of 15x. While PRU might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 Prudential
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for 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 PRU
Price-Earnings Ratio = Price per share ÷ Earnings per share
PRU Price-Earnings Ratio = £18.26 ÷ £1.068 = 17.1x
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 PRU, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 17.1x, PRU’s P/E is higher than its industry peers (15x). This implies that investors are overvaluing each dollar of PRU’s earnings. Therefore, according to this analysis, PRU is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your PRU shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to PRU. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with PRU, 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 PRU to are fairly valued by the market. If this is violated, PRU’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.