Should You Be Tempted To Buy Admiral Group plc (LON:ADM) Because Of Its PE Ratio?
Admiral Group plc (LSE:ADM) trades with a trailing P/E of 16.6x, which is lower than the industry average of 17.7x. While this makes ADM 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Admiral Group
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 pound of the company’s earnings.
P/E Calculation for ADM
Price-Earnings Ratio = Price per share ÷ Earnings per share
ADM Price-Earnings Ratio = £19.41 ÷ £1.172 = 16.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 ADM, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 16.6x, ADM’s P/E is lower than its industry peers (17.7x). This implies that investors are undervaluing each dollar of ADM’s earnings. As such, our analysis shows that ADM represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that ADM 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 ADM. 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 ADM, 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 ADM to are fairly valued by the market. If this is violated, ADM’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on ADM, the undervaluation of the stock may mean it is a good time to top up on 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. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for ADM’s future growth? Take a look at our free research report of analyst consensus for ADM’s outlook.
Past Track Record: Has ADM been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of ADM’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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.
