SAP SE (DB:SAP) is currently trading at a trailing P/E of 27.9x, which is lower than the industry average of 36.9x. While SAP 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 SAP
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 SAP
Price-Earnings Ratio = Price per share ÷ Earnings per share
SAP Price-Earnings Ratio = €98.12 ÷ €3.517 = 27.9x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to SAP, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. SAP’s P/E of 27.9x is lower than its industry peers (36.9x), which implies that each dollar of SAP’s earnings is being undervalued by investors. Therefore, according to this analysis, SAP is an under-priced stock.
A few caveats
Before you jump to the conclusion that SAP 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 SAP. 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 SAP, 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 SAP to are fairly valued by the market. If this is violated, SAP’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
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 SAP. 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. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for SAP’s future growth? Take a look at our free research report of analyst consensus for SAP’s outlook.
- Past Track Record: Has SAP 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 SAP’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.