Advanced Medical Solutions Group plc (AIM:AMS) is trading with a trailing P/E of 41.2x, which is higher than the industry average of 30.9x. While AMS 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Advanced Medical Solutions Group
Breaking down the P/E 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 AMS
Price-Earnings Ratio = Price per share ÷ Earnings per share
AMS Price-Earnings Ratio = 3.42 ÷ 0.083 = 41.2x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to AMS, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since AMS’s P/E of 41.2x is higher than its industry peers (30.9x), it means that investors are paying more than they should for each dollar of AMS’s earnings. Therefore, according to this analysis, AMS is an over-priced stock.
A few caveats
However, before you rush out to sell your AMS shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to AMS, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with AMS, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing AMS to are fairly valued by the market. If this is violated, AMS’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in AMS. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in AMS, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 Advanced Medical Solutions 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.