This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Horus AG (BST:HRU) is currently trading at a trailing P/E of 3.6, which is lower than the industry average of 20.8. While this makes HRU appear like a good stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Breaking down the Price-Earnings 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 HRU
Price per share = €1.8
Earnings per share = €0.506
∴ Price-Earnings Ratio = €1.8 ÷ €0.506 = 3.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as HRU, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use below. 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 3.6, HRU’s P/E is lower than its industry peers (20.8). This implies that investors are undervaluing each dollar of HRU’s earnings. This multiple is a median of profitable companies of 14 Capital Markets companies in DE including mwb fairtrade Wertpapierhandelsbank, Lang & Schwarz and DWS Group GmbH KGaA. One could put it like this: the market is pricing HRU as if it is a weaker company than the average company in its industry.
A few caveats
However, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to HRU. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with HRU, then HRU’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with HRU, HRU’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing HRU to are fairly valued by the market. If this assumption does not hold true, HRU’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of HRU to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for HRU’s future growth? Take a look at our free research report of analyst consensus for HRU’s outlook.
- Past Track Record: Has HRU 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 HRU’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 firstname.lastname@example.org.