Tahoe Resources Inc (TSX:THO) is trading with a trailing P/E of 18.2x, which is higher than the industry average of 9.9x. While this makes THO 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. See our latest analysis for Tahoe Resources
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. 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 THO
Price per share = $4.76
Earnings per share = $0.261
∴ Price-Earnings Ratio = $4.76 ÷ $0.261 = 18.2x
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 THO, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use below. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
At 18.2x, THO’s P/E is higher than its industry peers (9.9x). This implies that investors are overvaluing each dollar of THO’s earnings. Therefore, according to this analysis, THO is an over-priced stock.
A few caveats
However, before you rush out to sell your THO 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 THO. 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 THO, then THO’s P/E would naturally be higher since investors would reward THO’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with THO, THO’s P/E would again be higher since investors would reward THO’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing THO to are fairly valued by the market. If this assumption is violated, THO’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 THO, 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for THO’s future growth? Take a look at our free research report of analyst consensus for THO’s outlook.
- Past Track Record: Has THO 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 THO’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.