Should You Sell Qantm Intellectual Property Limited (ASX:QIP) At This PE Ratio?

Qantm Intellectual Property Limited (ASX:QIP) is trading with a trailing P/E of 28.7x, which is higher than the industry average of 21.9x. 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. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Qantm Intellectual Property

What you need to know about the P/E ratio

P/E is a popular ratio used for relative valuation. 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.

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to QIP, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.

At 28.7x, QIP’s P/E is higher than its industry peers (21.9x). This implies that investors are overvaluing each dollar of QIP’s earnings. As such, our analysis shows that QIP represents an over-priced stock.

A few caveats

Before you jump to the conclusion that QIP should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to QIP. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with QIP, then QIP’s P/E would naturally be higher since investors would reward QIP’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with QIP, QIP’s P/E would again be higher since investors would reward QIP’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing QIP to are fairly valued by the market. If this assumption is violated, QIP's P/E may be higher than its peers because its peers are actually undervalued by investors.

What this means for you:

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 QIP. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for QIP’s future growth? Take a look at our free research report of analyst consensus for QIP’s outlook.

2. Financial Health: Is QIP’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.