Should You Sell Old Mutual plc (LON:OML) At This PE Ratio?
Old Mutual plc (LSE:OML) is currently trading at a trailing P/E of 16.4x, which is higher than the industry average of 15x. 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. Check out our latest analysis for Old Mutual
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 OML
Price-Earnings Ratio = Price per share ÷ Earnings per share
OML Price-Earnings Ratio = £2.56 ÷ £0.156 = 16.4x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to OML, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. OML’s P/E of 16.4x is higher than its industry peers (15x), which implies that each dollar of OML’s earnings is being overvalued by investors. Therefore, according to this analysis, OML is an over-priced stock.
A few caveats
However, before you rush out to sell your OML 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 OML. 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 OML, 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 OML to are fairly valued by the market. If this does not hold true, OML’s lower P/E ratio may be because firms in our peer group are 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.
