Kinross Gold Corporation (TSX:K) is trading with a trailing P/E of 99.2x, which is higher than the industry average of 10.9x. While K 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 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 = 5.33 ÷ 0.043 = 99.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to K, 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. At 99.2x, K’s P/E is higher than its industry peers (10.9x). This implies that investors are overvaluing each dollar of K’s earnings. Therefore, according to this analysis, K is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your K shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to K, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with K, 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 K to are fairly valued by the market. If this is violated, K's P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on K, 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 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.