Hargreaves Lansdown plc (LSE:HL.) is currently trading at a trailing P/E of 36.6x, which is higher than the industry average of 15.3x. While HL. 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Hargreaves Lansdown
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 HL.
Price-Earnings Ratio = Price per share ÷ Earnings per share
HL. Price-Earnings Ratio = £17.3 ÷ £0.473 = 36.6x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as HL., such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 36.6x, HL.’s P/E is higher than its industry peers (15.3x). This implies that investors are overvaluing each dollar of HL.’s earnings. Therefore, according to this analysis, HL. is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that HL. should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to HL., or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with HL., 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 HL. to are fairly valued by the market. If this does not hold true, HL.’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to HL.. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 HL.’s future growth? Take a look at our free research report of analyst consensus for HL.’s outlook.
- Past Track Record: Has HL. 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 HL.’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.