Wheaton Precious Metals Corp (TSX:WPM) is trading with a trailing P/E of 42.2x, which is higher than the industry average of 9.9x. While WPM 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Wheaton Precious Metals
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 WPM
Price-Earnings Ratio = Price per share ÷ Earnings per share
WPM Price-Earnings Ratio = $19.69 ÷ $0.467 = 42.2x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to WPM, 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. WPM’s P/E of 42.2x is higher than its industry peers (9.9x), which implies that each dollar of WPM’s earnings is being overvalued by investors. As such, our analysis shows that WPM represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your WPM shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to WPM, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with WPM, 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 WPM to are fairly valued by the market. If this is violated, WPM’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.