Should You Be Tempted To Sell Ultra Electronics Holdings plc (LON:ULE) Because Of Its PE Ratio?
Ultra Electronics Holdings plc (LSE:ULE) is trading with a trailing P/E of 18.5x, which is higher than the industry average of 18.2x. 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. 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 Ultra Electronics Holdings
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 ULE
Price-Earnings Ratio = Price per share ÷ Earnings per share
ULE Price-Earnings Ratio = £15.15 ÷ £0.821 = 18.5x
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 ULE, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since ULE’s P/E of 18.5x is higher than its industry peers (18.2x), it means that investors are paying more than they should for each dollar of ULE’s earnings. Therefore, according to this analysis, ULE is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your ULE shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ULE, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with ULE, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing ULE to are fairly valued by the market. If this is violated, ULE’s P/E may be lower than its peers as they are actually overvalued by investors.
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.
