Should You Be Tempted To Buy Lateral Corporation Limited (NZE:LAT) At Its Current PE Ratio?
Lateral Corporation Limited (NZSE:LAT) is trading with a trailing P/E of 2.2x, which is lower than the industry average of 28.7x. While this makes LAT 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Lateral
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 LAT
Price-Earnings Ratio = Price per share ÷ Earnings per share
LAT Price-Earnings Ratio = NZ$0.02 ÷ NZ$0.009 = 2.2x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as LAT, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. LAT’s P/E of 2.2x is lower than its industry peers (28.7x), which implies that each dollar of LAT’s earnings is being undervalued by investors. Therefore, according to this analysis, LAT is an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that LAT 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 LAT, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with LAT, 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 LAT to are fairly valued by the market. If this does not hold, there is a possibility that LAT’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 LAT. 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 LAT 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 Lateral 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.
