Is It Time To Sell Treasury Wine Estates Limited (ASX:TWE) Based Off Its PE Ratio?
Treasury Wine Estates Limited (ASX:TWE) trades with a trailing P/E of 37.5x, which is higher than the industry average of 29x. While this makes TWE appear like a stock to avoid or sell if you own it, 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. View our latest analysis for Treasury Wine Estates
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 TWE
Price-Earnings Ratio = Price per share ÷ Earnings per share
TWE Price-Earnings Ratio = 13.71 ÷ 0.365 = 37.5x
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 TWE, 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. TWE’s P/E of 37.5x is higher than its industry peers (29x), which implies that each dollar of TWE’s earnings is being overvalued by investors. Therefore, according to this analysis, TWE is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that TWE should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to TWE. 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 TWE, 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 TWE to are fairly valued by the market. If this does not hold, there is a possibility that TWE’s P/E is lower because our peer group is overvalued by the market.
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 TWE. 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 TWE, 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 Treasury Wine Estates 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.
