The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in GEA Group Aktiengesellschaft (DB:G1A).
GEA Group Aktiengesellschaft (DB:G1A) trades with a trailing P/E of 30.6x, which is higher than the industry average of 22x. 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 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 GEA Group
Breaking down 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 G1A
Price per share = €31.74
Earnings per share = €1.036
∴ Price-Earnings Ratio = €31.74 ÷ €1.036 = 30.6x
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 G1A, 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 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 30.6x, G1A’s P/E is higher than its industry peers (22x). This implies that investors are overvaluing each dollar of G1A’s earnings. Therefore, according to this analysis, G1A is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your G1A shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to G1A. 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 G1A, then G1A’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 G1A. In this case, G1A’s P/E would be higher since investors would also reward G1A’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing G1A to are fairly valued by the market. If this assumption does not hold true, G1A’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 G1A. 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 G1A’s future growth? Take a look at our free research report of analyst consensus for G1A’s outlook.
- Past Track Record: Has G1A 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 G1A’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.