Should You Be Tempted To Buy Southern Gold Limited (ASX:SAU) Because Of Its PE Ratio?
Southern Gold Limited (ASX:SAU) is currently trading at a trailing P/E of 5.3x, which is lower than the industry average of 13.7x. While SAU 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. View our latest analysis for Southern Gold
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 SAU
Price-Earnings Ratio = Price per share ÷ Earnings per share
SAU Price-Earnings Ratio = A$0.24 ÷ A$0.046 = 5.3x
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 SAU, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 5.3x, SAU’s P/E is lower than its industry peers (13.7x). This implies that investors are undervaluing each dollar of SAU’s earnings. Therefore, according to this analysis, SAU is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy SAU immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to SAU, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with SAU, 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 SAU to are fairly valued by the market. If this does not hold true, SAU’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.
