Should You Be Tempted To Buy Lucara Diamond Corp (TSE:LUC) At Its Current PE Ratio?
Lucara Diamond Corp (TSX:LUC) trades with a trailing P/E of 10.6x, which is lower than the industry average of 12.2x. While LUC 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. 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 Lucara Diamond
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 LUC
Price-Earnings Ratio = Price per share ÷ Earnings per share
LUC Price-Earnings Ratio = $2.07 ÷ $0.196 = 10.6x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 LUC, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. LUC’s P/E of 10.6x is lower than its industry peers (12.2x), which implies that each dollar of LUC’s earnings is being undervalued by investors. Therefore, according to this analysis, LUC is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy LUC immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to LUC. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with LUC, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing LUC to are fairly valued by the market. If this does not hold true, LUC’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.
