Kinross Gold Corporation (TSX:K) trades with a trailing P/E of 46.5x, which is higher than the industry average of 11.6x. 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 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 Kinross Gold
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 dollar of the company’s earnings.
P/E Calculation for K
Price-Earnings Ratio = Price per share ÷ Earnings per share
K Price-Earnings Ratio = $4.15 ÷ $0.089 = 46.5x
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 K, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since K’s P/E of 46.5x is higher than its industry peers (11.6x), it means that investors are paying more than they should for each dollar of K’s earnings. As such, our analysis shows that K represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your K shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to K. 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 K, 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 K to are fairly valued by the market. If this does not hold, there is a possibility that K’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 K. 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 K 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 Kinross Gold 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.