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.
Acheter-LouerFr SA (EPA:ALALO) trades with a trailing P/E of 36.8x, which is higher than the industry average of 24.3x. While this makes ALALO 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. 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.
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 ALALO
Price per share = €0.035
Earnings per share = €0.000940
∴ Price-Earnings Ratio = €0.035 ÷ €0.000940 = 36.8x
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 ALALO, such as company lifetime and products sold. 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.
ALALO’s P/E of 36.8x is higher than its industry peers (24.3x), which implies that each dollar of ALALO’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 5 Internet companies in FR including ADThink Media Societe Anonyme, Nextedia and Netgem. As such, our analysis shows that ALALO represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your ALALO shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ALALO. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared riskier firms with ALALO, then investors would naturally value ALALO at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with ALALO, investors would also value ALALO at a higher price since it is a higher growth investment. Both scenarios would explain why ALALO has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing ALALO to are fairly valued by the market. If this does not hold, there is a possibility that ALALO’s P/E is higher because firms in our peer group are being undervalued by the market.
What this means for you:
Since you may have already conducted your due diligence on ALALO, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I've outlined 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:
- Financial Health: Are ALALO’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 ALALO 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 ALALO'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.
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Simply Wall St has no position in any of the companies mentioned. This article is general in nature. 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.
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