Grifols SA. (BME:GRF) is trading with a trailing P/E of 23.2x, which is lower than the industry average of 28.5x. While this makes GRF appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Grifols
Demystifying 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 dollar of the company’s earnings.
P/E Calculation for GRF
Price-Earnings Ratio = Price per share ÷ Earnings per share
GRF Price-Earnings Ratio = €22.44 ÷ €0.969 = 23.2x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to GRF, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. GRF’s P/E of 23.2x is lower than its industry peers (28.5x), which implies that each dollar of GRF’s earnings is being undervalued by investors. Therefore, according to this analysis, GRF is an under-priced stock.
A few caveats
Before you jump to the conclusion that GRF is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to GRF, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with GRF, 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 GRF to are fairly valued by the market. If this is violated, GRF’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.