Should You Be Tempted To Sell Polar Capital Holdings plc (LON:POLR) At Its Current PE Ratio?
Polar Capital Holdings plc (AIM:POLR) trades with a trailing P/E of 21.7x, which is higher than the industry average of 17x. While POLR might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Polar Capital Holdings
Breaking down the Price-Earnings 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 pound of the company’s earnings.
P/E Calculation for POLR
Price-Earnings Ratio = Price per share ÷ Earnings per share
POLR Price-Earnings Ratio = £4.63 ÷ £0.213 = 21.7x
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 POLR, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 21.7x, POLR’s P/E is higher than its industry peers (17x). This implies that investors are overvaluing each dollar of POLR’s earnings. As such, our analysis shows that POLR represents an over-priced stock.
A few caveats
Before you jump to the conclusion that POLR should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to POLR, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with POLR, 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 POLR to are fairly valued by the market. If this does not hold true, POLR’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.
