This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Touchstone Exploration Inc (TSE:TXP).
Touchstone Exploration Inc (TSE:TXP) is currently trading at a trailing P/E of 35.6x, which is higher than the industry average of 19.4x. While TXP might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Touchstone Exploration
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in 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 TXP
Price per share = CA$0.24
Earnings per share = CA$0.00688
∴ Price-Earnings Ratio = CA$0.24 ÷ CA$0.00688 = 35.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to TXP, 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. 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 TXP’s P/E of 35.6x is higher than its industry peers (19.4x), it means that investors are paying more than they should for each dollar of TXP’s earnings. Therefore, according to this analysis, TXP is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your TXP shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to TXP. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with TXP, then TXP’s P/E would naturally be higher since investors would reward TXP’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with TXP, TXP’s P/E would again be higher since investors would reward TXP’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing TXP to are fairly valued by the market. If this assumption is violated, TXP’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 TXP. 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:
- Financial Health: Is TXP’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.
- Past Track Record: Has TXP 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 TXP’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.