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 Gossan Resources Limited (CVE:GSS).
Gossan Resources Limited (CVE:GSS) is currently trading at a trailing P/E of 14.9x, which is higher than the industry average of 11x. While GSS 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. 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 Gossan Resources
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 GSS
Price per share = CA$0.075
Earnings per share = CA$0.00503
∴ Price-Earnings Ratio = CA$0.075 ÷ CA$0.00503 = 14.9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against 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 GSS, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. 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 14.9x, GSS’s P/E is higher than its industry peers (11x). This implies that investors are overvaluing each dollar of GSS’s earnings. As such, our analysis shows that GSS represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your GSS shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to GSS. 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 GSS, then GSS’s P/E would naturally be higher since investors would reward GSS’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with GSS, GSS’s P/E would again be higher since investors would reward GSS’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing GSS to are fairly valued by the market. If this assumption is violated, GSS’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 GSS, 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:
- Financial Health: Is GSS’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 GSS 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 GSS’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.