I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Poltronic SA (WSE:PTN) is currently trading at a trailing P/E of 6.2x, which is lower than the industry average of 8.8x. While PTN 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 PTN
Price-Earnings Ratio = Price per share ÷ Earnings per share
PTN Price-Earnings Ratio = PLN0.26 ÷ PLN0.0416 = 6.2x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to PTN, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. PTN’s P/E of 6.2 is lower than its industry peers (8.8), which implies that each dollar of PTN’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 15 Trade Distributors companies in PL including AviaAM Leasing, Bowim and Szar Spólka Akcyjna. One could put it like this: the market is pricing PTN as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to PTN. 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 PTN, 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 PTN to are fairly valued by the market. If this does not hold true, PTN’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of PTN to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 PTN’s future growth? Take a look at our free research report of analyst consensus for PTN’s outlook.
- Past Track Record: Has PTN 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 PTN’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 past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.