Is It Time To Sell Phileo Australia Limited (ASX:PHI) Based Off Its PE Ratio?
Phileo Australia Limited (ASX:PHI) is currently trading at a trailing P/E of 13.3x, which is higher than the industry average of 11.5x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for PHI
Breaking down the P/E ratio
P/E is a popular ratio used for relative valuation. 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 dollar of the company’s earnings.
P/E Calculation for PHI
Price-Earnings Ratio = Price per share ÷ Earnings per share
PHI Price-Earnings Ratio = 10.75 ÷ 0.809 = 13.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to PHI, 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. PHI’s P/E of 13.3x is higher than its industry peers (11.5x), which implies that each dollar of PHI’s earnings is being overvalued by investors. Therefore, according to this analysis, PHI is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your PHI shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to PHI. 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 PHI, 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 PHI to are fairly valued by the market. If this does not hold, there is a possibility that PHI’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to PHI. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If PHI has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
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 Phileo Australia 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.
