Should You Be Tempted To Buy Western Troy Capital Resources Inc (TSXV:WRY) Because Of Its PE Ratio?
Western Troy Capital Resources Inc (TSXV:WRY) is currently trading at a trailing P/E of 0.9x, which is lower than the industry average of 19.3x. While WRY 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for WRY
Breaking down the P/E 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.
Formula
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for WRY
Price per share = 0.03
Earnings per share = 0.033
∴ Price-Earnings Ratio = 0.03 ÷ 0.033 = 0.9x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to WRY, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
WRY’s P/E of 0.9x is lower than its industry peers (19.3x), which implies that each dollar of WRY’s earnings is being undervalued by investors. Therefore, according to this analysis, WRY is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy WRY immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to WRY. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with WRY, then investors would naturally value WRY at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with WRY, investors would also value WRY at a lower price since it is a lower growth investment. Both scenarios would explain why WRY has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing WRY to are fairly valued by the market. If this assumption is violated, WRY's P/E may be lower than its peers because its peers are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on WRY, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I've outlined above.
Are you a potential investor? If you are considering investing in WRY, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 Western Troy Capital Resources 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.
