Liberty Global plc (NASDAQ:LBTY.A) is currently trading at a trailing P/E of 84.2x, which is higher than the industry average of 19.7x. 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. View our latest analysis for Liberty Global
Demystifying 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 LBTY.A
Price-Earnings Ratio = Price per share ÷ Earnings per share
LBTY.A Price-Earnings Ratio = $35.25 ÷ $0.419 = 84.2x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to LBTY.A, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since LBTY.A’s P/E of 84.2x is higher than its industry peers (19.7x), it means that investors are paying more than they should for each dollar of LBTY.A’s earnings. As such, our analysis shows that LBTY.A represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your LBTY.A 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 LBTY.A. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with LBTY.A, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing LBTY.A to are fairly valued by the market. If this does not hold true, LBTY.A’s lower P/E ratio may be because firms in our peer group are expensive by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on LBTY.A, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above.
Are you a potential investor? If you are considering investing in LBTY.A, 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 Liberty Global 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.