Grenke AG (XTRA:GLJ) is currently trading at a trailing P/E of 32.8x, which is higher than the industry average of 11.8x. While this makes GLJ appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, 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 Grenke
Demystifying 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 GLJ
Price-Earnings Ratio = Price per share ÷ Earnings per share
GLJ Price-Earnings Ratio = €89.85 ÷ €2.736 = 32.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to GLJ, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since GLJ’s P/E of 32.8x is higher than its industry peers (11.8x), it means that investors are paying more than they should for each dollar of GLJ’s earnings. Therefore, according to this analysis, GLJ is an over-priced stock.
A few caveats
Before you jump to the conclusion that GLJ should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to GLJ. 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 GLJ, 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 GLJ to are fairly valued by the market. If this does not hold, there is a possibility that GLJ’s P/E is lower because our peer group is 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.