Should You Sell Fevertree Drinks Plc (LON:FEVR) At This PE Ratio?
Fevertree Drinks Plc (AIM:FEVR) trades with a trailing P/E of 66.2x, which is higher than the industry average of 23.7x. 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Fevertree Drinks
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 FEVR
Price-Earnings Ratio = Price per share ÷ Earnings per share
FEVR Price-Earnings Ratio = £21.54 ÷ £0.326 = 66.2x
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 FEVR, 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. FEVR’s P/E of 66.2x is higher than its industry peers (23.7x), which implies that each dollar of FEVR’s earnings is being overvalued by investors. As such, our analysis shows that FEVR represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your FEVR shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to FEVR. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with FEVR, 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 FEVR to are fairly valued by the market. If this does not hold, there is a possibility that FEVR’s P/E is lower because our peer group is overvalued by the market.
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 FEVR. 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 FEVR has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
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 Fevertree Drinks 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.
