Is SSE plc’s (LSE:SSE) PE Ratio A Signal To Buy For Investors?
SSE plc (LSE:SSE) trades with a trailing P/E of 8.7x, which is lower than the industry average of 21x. While this makes SSE appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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. See our latest analysis for SSE
What you need to know about 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 SSE
Price-Earnings Ratio = Price per share ÷ Earnings per share
SSE Price-Earnings Ratio = 13.86 ÷ 1.584 = 8.7x
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 SSE, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since SSE's P/E of 8.7x is lower than its industry peers (21x), it means that investors are paying less than they should for each dollar of SSE's earnings. Therefore, according to this analysis, SSE is an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that SSE is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to SSE. 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 SSE, 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 SSE to are fairly valued by the market. If this does not hold, there is a possibility that SSE’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 undervaluation could signal a good buying opportunity to increase your exposure to SSE. 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 you are considering investing in SSE, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 SSE 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.
