Is It Time To Sell Empiric Student Property plc (LON:ESP) Based Off Its PE Ratio?
Empiric Student Property plc (LSE:ESP) is trading with a trailing P/E of 12.8x, which is higher than the industry average of 10.9x. While ESP 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. View our latest analysis for Empiric Student Property
Breaking down the Price-Earnings 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 ESP
Price-Earnings Ratio = Price per share ÷ Earnings per share
ESP Price-Earnings Ratio = £0.83 ÷ £0.065 = 12.8x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 ESP, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since ESP’s P/E of 12.8x is higher than its industry peers (10.9x), it means that investors are paying more than they should for each dollar of ESP’s earnings. As such, our analysis shows that ESP represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your ESP 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 ESP. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with ESP, 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 ESP to are fairly valued by the market. If this is violated, ESP’s P/E may be lower than its peers as they are actually overpriced by investors.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in ESP. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in ESP, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Empiric Student Property for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
