United Overseas Australia Limited (ASX:UOS) is currently trading at a trailing P/E of 5.5x, which is lower than the industry average of 14.7x. While UOS might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for United Overseas Australia
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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for UOS
Price per share = A$0.65
Earnings per share = A$0.117
∴ Price-Earnings Ratio = A$0.65 ÷ A$0.117 = 5.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to UOS, 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 5.5x, UOS’s P/E is lower than its industry peers (14.7x). This implies that investors are undervaluing each dollar of UOS’s earnings. Therefore, according to this analysis, UOS is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy UOS immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to UOS. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared higher growth firms with UOS, then UOS’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with UOS, UOS’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing UOS to are fairly valued by the market. If this assumption is violated, UOS’s P/E may be lower than its peers because its peers are actually overvalued 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 add more of UOS to your portfolio. 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 urge you to complete your research by taking a look at the following:
1. Financial Health: Is UOS’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.
2. Past Track Record: Has UOS been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of UOS’s historicals for more clarity.
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.