I am writing today to help inform people who are new to the stock market and want to begin learning the link between Aberdeen International Inc (TSE:AAB)’s fundamentals and stock market performance.
Aberdeen International Inc (TSE:AAB) is currently trading at a trailing P/E of 1.5x, which is lower than the industry average of 12x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. 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 Aberdeen International
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for AAB
Price per share = CA$0.14
Earnings per share = CA$0.0942
∴ Price-Earnings Ratio = CA$0.14 ÷ CA$0.0942 = 1.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as AAB, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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.
Since AAB’s P/E of 1.5x is lower than its industry peers (12x), it means that investors are paying less than they should for each dollar of AAB’s earnings. This multiple is a median of profitable companies of 24 Capital Markets companies in CA including Q Investments, CBi2 Capital and ThreeD Capital. Therefore, according to this analysis, AAB is an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that AAB represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to AAB. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with AAB, then investors would naturally value AAB at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with AAB, investors would also value AAB at a lower price since it is a lower growth investment. Both scenarios would explain why AAB has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing AAB to are fairly valued by the market. If this assumption does not hold true, AAB’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
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 AAB 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:
- Future Outlook: What are well-informed industry analysts predicting for AAB’s future growth? Take a look at our free research report of analyst consensus for AAB’s outlook.
- Past Track Record: Has AAB 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 AAB’s historicals for more clarity.
- 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.