Should You Be Tempted To Sell SHW AG (FRA:SW1) Because Of Its PE Ratio?

The current price of SW1 places the company at a large trailing PE of 21.89x, more than 1.55 times above the DE Auto Components’s average of 14.13x. But should this larger multiple be the final verdict of SW1’s overvaluation? No. This is because multiples like PE tend to overlook key company-specific factors such as future growth and capital structure. Below, I will lay out some important considerations to help determine which multiple best suits the fast-growing company, SW1. Let’s take a look below.

How much does SW1 earn?

PE is only used when a company is profitable, such as SW1. This is because using PE to value an unprofitable business is flawed since the company has negative earnings (this will create a negative ratio). For these companies, it is possible to compare price to other fundamentals like sales or book value where applicable. SW1’s previous earnings record has continuously produced positive numbers. With upcoming earnings expected to remain positive, PE can be a valid multiple to apply to the company, however, there may be a better option.

DB:SW1 Future Profit July 10th 18
DB:SW1 Future Profit July 10th 18

Is SW1 in a lot of debt?

The business is appropriately levered which means there’s no real concern over the level of money owed. Currently, ’s debt represents 18.95% of equity, meaning that for every €1 you invest, the company owes €0.19 to debtors. Though this range is relatively optimal, investors should still be aware of the risks associated with debt obligations, in particular the priority over asset claims in the case of bankruptcy.

DB:SW1 Historical Debt July 10th 18
DB:SW1 Historical Debt July 10th 18
You may be wondering how debt impacts an equity valuation. Well, the company’s share price theoretically represents the value of its equity portion only. However, it’s crucial to account for debt as well, since debt represents a liability to the owner, and it impacts the earnings capacity and risk profile of the company. This can be done using enterprise value (EV) instead of share price. EV adds in debt and subtracts cash in order to recognise both sources of funding and is commonly used in the EV/EBITDA multiple.

SW1’s EV/EBITDA = €242.06m / €0 = 6.18x

SW1’s multiple appears appropriately valued relative to the industry’s average of 6.18x, in contrast to the price-to-earnings multiple which suggested the company was selling at a premium to fair value.

Will SW1 experience high growth?

Yes. If analyst predictions are right, the company’s earnings are forecasted to grow by 40.95% every year for the next 5 years. The issue with using current earnings in the denominator of a multiple is that it doesn’t reflect this expected growth, which is a limitation for using past (or “trailing”) values of EBITDA. You should pay for what you’re going to get, not what’s already happened. To account for this growth we can use the one-year analyst-consensus future EBITDA (this is a “forward” multiple).

SW1’s forward EV/EBITDA = €242.06m /€51.66m = 4.69x

The 5.69x average multiple for the industry suggests that SW1 is undervalued relative to its peers. which differs from the fair market value SW1’s past EV/EBITDA ratio suggested.

Next Steps:

Looking at relative valuation alone does not give you a complete picture of an investment. There are many important factors I have not taken into account in this article. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for ’s future growth? Take a look at our free research report of analyst consensus for ’s outlook.
  2. Past Track Record: Has 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 ‘s historicals for more clarity.
  3. 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.