Etteplan Oyj (HLSE:ETTE) is currently trading at a trailing P/E of 16.7x, which is lower than the industry average of 28.9x. While ETTE might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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. Check out our latest analysis for Etteplan Oyj
What you need to know about the P/E ratio
P/E is a popular ratio used for relative valuation. 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 ETTE
Price per share = €7.78
Earnings per share = €0.465
∴ Price-Earnings Ratio = €7.78 ÷ €0.465 = 16.7x
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 ETTE, 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 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 16.7x, ETTE’s P/E is lower than its industry peers (28.9x). This implies that investors are undervaluing each dollar of ETTE’s earnings. As such, our analysis shows that ETTE represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that ETTE represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to ETTE. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with ETTE, then investors would naturally value ETTE at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with ETTE, investors would also value ETTE at a lower price since it is a lower growth investment. Both scenarios would explain why ETTE has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing ETTE to are fairly valued by the market. If this assumption is violated, ETTE’s P/E may be lower than its peers because its peers are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to ETTE. 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 ETTE’s future growth? Take a look at our free research report of analyst consensus for ETTE’s outlook.
- Past Track Record: Has ETTE 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 ETTE’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.