This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Mincon Group plc (LON:MCON) trades with a trailing P/E of 28.8x, which is higher than the industry average of 19.7x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Mincon Group
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 pound of the company’s earnings.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for MCON
Price per share = €1.38
Earnings per share = €0.0479
∴ Price-Earnings Ratio = €1.38 ÷ €0.0479 = 28.8x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with 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 MCON, 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.
Since MCON’s P/E of 28.8x is higher than its industry peers (19.7x), it means that investors are paying more than they should for each dollar of MCON’s earnings. This multiple is a median of profitable companies of 20 Machinery companies in GB including 600 Group, Morgan Advanced Materials and Tex Holdings. Therefore, according to this analysis, MCON is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your MCON shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to MCON. 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 MCON, then MCON’s P/E would naturally be higher since investors would reward MCON’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with MCON, MCON’s P/E would again be higher since investors would reward MCON’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing MCON to are fairly valued by the market. If this does not hold, there is a possibility that MCON’s P/E is higher because firms in our peer group are being undervalued by the market.
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 MCON. 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:
- Future Outlook: What are well-informed industry analysts predicting for MCON’s future growth? Take a look at our free research report of analyst consensus for MCON’s outlook.
- Past Track Record: Has MCON 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 MCON’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.