Is It Time To Buy Legal & General Group Plc (LON:LGEN) Based Off Its PE Ratio?
Legal & General Group Plc (LSE:LGEN) trades with a trailing P/E of 8.6x, which is lower than the industry average of 15.2x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, 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 Legal & General Group
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 pound of the company’s earnings.
P/E Calculation for LGEN
Price-Earnings Ratio = Price per share ÷ Earnings per share
LGEN Price-Earnings Ratio = £2.63 ÷ £0.305 = 8.6x
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 LGEN, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. LGEN’s P/E of 8.6x is lower than its industry peers (15.2x), which implies that each dollar of LGEN’s earnings is being undervalued by investors. As such, our analysis shows that LGEN represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy LGEN, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to LGEN. 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 LGEN, 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 LGEN to are fairly valued by the market. If this does not hold, there is a possibility that LGEN’s P/E is lower because our peer group is 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.
