Distil plc (AIM:DIS) is currently trading at a trailing P/E of 122.5x, which is higher than the industry average of 23.7x. While DIS 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 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 Distil
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 pound of the company’s earnings.
P/E Calculation for DIS
Price-Earnings Ratio = Price per share ÷ Earnings per share
DIS Price-Earnings Ratio = £0.02 ÷ £0 = 122.5x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to DIS, 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. DIS’s P/E of 122.5x is higher than its industry peers (23.7x), which implies that each dollar of DIS’s earnings is being overvalued by investors. Therefore, according to this analysis, DIS is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your DIS shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to DIS. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with DIS, 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 DIS to are fairly valued by the market. If this does not hold, there is a possibility that DIS’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on DIS, 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.
Are you a potential investor? If you are considering investing in DIS, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 Distil 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.