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 Grammer AG (DB:GMM).
Grammer AG (DB:GMM) trades with a trailing P/E of 25.6x, which is higher than the industry average of 16x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. 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 Grammer
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 GMM
Price per share = €63.45
Earnings per share = €2.483
∴ Price-Earnings Ratio = €63.45 ÷ €2.483 = 25.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to GMM, 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.
Since GMM’s P/E of 25.6x is higher than its industry peers (16x), it means that investors are paying more than they should for each dollar of GMM’s earnings. As such, our analysis shows that GMM represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your GMM shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to GMM. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing riskier firms with GMM, then GMM’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with GMM. In this case, GMM’s P/E would be higher since investors would also reward GMM’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing GMM to are fairly valued by the market. If this assumption does not hold true, GMM’s higher P/E ratio may be because firms in our peer group are being undervalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to GMM. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 GMM’s future growth? Take a look at our free research report of analyst consensus for GMM’s outlook.
- Past Track Record: Has GMM 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 GMM’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.