Allgäuer Brauhaus AG (MUN:ALB) is currently trading at a trailing P/E of 57.9x, which is higher than the industry average of 24.5x. While ALB might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Allgäuer Brauhaus
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 ALB
Price per share = €640
Earnings per share = €11.046
∴ Price-Earnings Ratio = €640 ÷ €11.046 = 57.9x
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 ALB, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. 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.
ALB’s P/E of 57.9x is higher than its industry peers (24.5x), which implies that each dollar of ALB’s earnings is being overvalued by investors. Therefore, according to this analysis, ALB is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your ALB shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ALB. 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 ALB, then ALB’s P/E would naturally be higher since investors would reward ALB’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with ALB, ALB’s P/E would again be higher since investors would reward ALB’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing ALB to are fairly valued by the market. If this assumption is violated, ALB’s P/E may be higher than its peers because its peers are actually undervalued by investors.
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 ALB. 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 urge you to complete your research by taking a look at the following:
- Financial Health: Is ALB’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has ALB 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 ALB’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.