This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Sonel SA (WSE:SON) trades with a trailing P/E of 17x, which is higher than the industry average of 7.7x. While SON 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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.
P/E Calculation for SON
Price-Earnings Ratio = Price per share ÷ Earnings per share
SON Price-Earnings Ratio = PLN6.16 ÷ PLN0.362 = 17x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SON, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 17x, SON’s P/E is higher than its industry peers (7.7x). This implies that investors are overvaluing each dollar of SON’s earnings. This multiple is a median of profitable companies of 9 Electronic companies in PL including ASBISc Enterprises, AB and Eurotel. As such, our analysis shows that SON represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your SON shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to SON. 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 SON, 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 SON to are fairly valued by the market. If this is violated, SON’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on SON, the overvaluation of the stock may mean it is a good time to reduce 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. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for SON’s future growth? Take a look at our free research report of analyst consensus for SON’s outlook.
- Past Track Record: Has SON 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 SON’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 past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.