Genesis Energy Limited (NZSE:GNE) trades with a trailing P/E of 21.8x, which is lower than the industry average of 22.3x. While GNE might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 Genesis Energy
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 dollar of the company’s earnings.
P/E Calculation for GNE
Price-Earnings Ratio = Price per share ÷ Earnings per share
GNE Price-Earnings Ratio = NZ$2.4 ÷ NZ$0.11 = 21.8x
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 GNE, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. GNE’s P/E of 21.8x is lower than its industry peers (22.3x), which implies that each dollar of GNE’s earnings is being undervalued by investors. As such, our analysis shows that GNE represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that GNE is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to GNE, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with GNE, 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 GNE to are fairly valued by the market. If this does not hold true, GNE’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.