This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Leifheit Aktiengesellschaft (FRA:LEI) is trading with a trailing P/E of 15.1x, which is higher than the industry average of 13.6x. While this makes LEI appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Demystifying 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for LEI
Price per share = €19.88
Earnings per share = €1.314
∴ Price-Earnings Ratio = €19.88 ÷ €1.314 = 15.1x
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 LEI, 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 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 15.1x, LEI’s P/E is higher than its industry peers (13.6x). This implies that investors are overvaluing each dollar of LEI’s earnings. This multiple is a median of profitable companies of 25 Consumer Durables companies in DE including Samson Holding, Live Ventures and Vivanco Gruppe. As such, our analysis shows that LEI represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that LEI should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to LEI. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with LEI, then LEI’s P/E would naturally be higher since investors would reward LEI’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with LEI, LEI’s P/E would again be higher since investors would reward LEI’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing LEI to are fairly valued by the market. If this does not hold, there is a possibility that LEI’s P/E is higher 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 LEI. 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 LEI’s future growth? Take a look at our free research report of analyst consensus for LEI’s outlook.
- Past Track Record: Has LEI 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 LEI’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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.