HomeServe plc (LSE:HSV) trades with a trailing P/E of 30.8x, which is higher than the industry average of 19.6x. 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. In this article, 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 HomeServe
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in 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 HSV
Price-Earnings Ratio = Price per share ÷ Earnings per share
HSV Price-Earnings Ratio = £7.3 ÷ £0.237 = 30.8x
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 HSV, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 30.8x, HSV’s P/E is higher than its industry peers (19.6x). This implies that investors are overvaluing each dollar of HSV’s earnings. Therefore, according to this analysis, HSV is an over-priced stock.
A few caveats
Before you jump to the conclusion that HSV should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to HSV. 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 HSV, 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 HSV to are fairly valued by the market. If this does not hold, there is a possibility that HSV’s P/E is lower because our peer group is overvalued by the market.
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.