The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Sandstorm Gold Ltd (TSE:SSL)’s fundamentals and stock market performance.
Sandstorm Gold Ltd (TSE:SSL) trades with a trailing P/E of 196.9x, which is higher than the industry average of 11.2x. While this makes SSL 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 out our latest analysis for Sandstorm Gold
What you need to know about the P/E 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 SSL
Price per share = $4.43
Earnings per share = $0.0225
∴ Price-Earnings Ratio = $4.43 ÷ $0.0225 = 196.9x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 SSL, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use below. 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 196.9x, SSL’s P/E is higher than its industry peers (11.2x). This implies that investors are overvaluing each dollar of SSL’s earnings. Therefore, according to this analysis, SSL is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your SSL shares, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to SSL. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with SSL, then investors would naturally value SSL at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with SSL, investors would also value SSL at a higher price since it is a higher growth investment. Both scenarios would explain why SSL has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing SSL to are fairly valued by the market. If this assumption is violated, SSL’s P/E may be higher than its peers because its peers are actually undervalued by investors.
What this means for you:
Since you may have already conducted your due diligence on SSL, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 SSL’s future growth? Take a look at our free research report of analyst consensus for SSL’s outlook.
- Past Track Record: Has SSL 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 SSL’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.