Should You Sell Sky plc (LON:SKY) At This PE Ratio?
Sky plc (LSE:SKY) is trading with a trailing P/E of 25x, which is higher than the industry average of 23.5x. While this makes SKY appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Sky
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 SKY
Price-Earnings Ratio = Price per share ÷ Earnings per share
SKY Price-Earnings Ratio = £10.15 ÷ £0.406 = 25x
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 SKY, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since SKY’s P/E of 25x is higher than its industry peers (23.5x), it means that investors are paying more than they should for each dollar of SKY’s earnings. As such, our analysis shows that SKY represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that SKY 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 SKY. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with SKY, 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 SKY to are fairly valued by the market. If this does not hold, there is a possibility that SKY’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? 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 SKY. 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.
Are you a potential investor? If SKY 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 Sky 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.
