Should You Sell Spark Infrastructure Group (ASX:SKI) At This PE Ratio?
Spark Infrastructure Group (ASX:SKI) trades with a trailing P/E of 45x, which is higher than the industry average of 22.3x. 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 Spark Infrastructure Group
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for SKI
Price-Earnings Ratio = Price per share ÷ Earnings per share
SKI Price-Earnings Ratio = A$2.37 ÷ A$0.053 = 45x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 SKI, 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. Since SKI’s P/E of 45x is higher than its industry peers (22.3x), it means that investors are paying more than they should for each dollar of SKI’s earnings. Therefore, according to this analysis, SKI is an over-priced stock.
A few caveats
Before you jump to the conclusion that SKI should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to SKI, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with SKI, 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 SKI to are fairly valued by the market. If this does not hold, there is a possibility that SKI’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.
