Is Scandinavian Tobacco Group A/S (CPSE:STG) A Buy At Its Current PE Ratio?

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 Scandinavian Tobacco Group A/S (CPSE:STG).

Scandinavian Tobacco Group A/S (CPSE:STG) is trading with a trailing P/E of 12.7x, which is lower than the industry average of 13.8x. While this makes STG appear like a great 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. See our latest analysis for Scandinavian Tobacco Group

What you need to know about 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.

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as STG, such as size and country of operation. 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.

STG’s P/E of 12.7x is lower than its industry peers (13.8x), which implies that each dollar of STG’s earnings is being undervalued by investors. As such, our analysis shows that STG represents an under-priced stock.

Assumptions to be aware of

Before you jump to the conclusion that STG represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to STG. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with STG, then investors would naturally value STG at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with STG, investors would also value STG at a lower price since it is a lower growth investment. Both scenarios would explain why STG has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing STG to are fairly valued by the market. If this assumption does not hold true, STG’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 STG 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 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 STG’s future growth? Take a look at our free research report of analyst consensus for STG’s outlook.
2. Past Track Record: Has STG 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 STG'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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.