ALDA Spólka Akcyjna (WSE:ALD) is currently trading at a trailing P/E of 86.1x, which is higher than the industry average of 12.8x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for ALDA Spólka Akcyjna
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 ALD
Price-Earnings Ratio = Price per share ÷ Earnings per share
ALD Price-Earnings Ratio = PLN2.54 ÷ PLN0.029 = 86.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as ALD, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since ALD’s P/E of 86.1x is higher than its industry peers (12.8x), it means that investors are paying more than they should for each dollar of ALD’s earnings. As such, our analysis shows that ALD represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your ALD shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ALD, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with ALD, 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 ALD to are fairly valued by the market. If this does not hold, there is a possibility that ALD’s P/E is lower because our peer group is 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 rebalance your portfolio and reduce your holdings in ALD. 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 highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is ALD’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has ALD 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 ALD’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.