This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Asbestos Corporation Limited (CVE:AB.H).
Asbestos Corporation Limited (CVE:AB.H) is currently trading at a trailing P/E of 5x, which is lower than the industry average of 10.7x. While this makes AB.H appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Asbestos
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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.
Formula
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for AB.H
Price per share = CA$0.80
Earnings per share = CA$0.159
∴ Price-Earnings Ratio = CA$0.80 ÷ CA$0.159 = 5x
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 AB.H, 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 5x, AB.H’s P/E is lower than its industry peers (10.7x). This implies that investors are undervaluing each dollar of AB.H’s earnings. This multiple is a median of profitable companies of 25 Metals and Mining companies in CA including Winston Resources, Knick Exploration and Stelco Holdings. Therefore, according to this analysis, AB.H is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy AB.H immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to AB.H. 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 AB.H, then investors would naturally value AB.H at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with AB.H, investors would also value AB.H at a lower price since it is a lower growth investment. Both scenarios would explain why AB.H has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing AB.H to are fairly valued by the market. If this does not hold, there is a possibility that AB.H’s P/E is lower because firms in our peer group are being overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on AB.H, the undervaluation of the stock may mean it is a good time to top up on 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:
- Financial Health: Is AB.H’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 AB.H 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 AB.H’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.