I am writing today to help inform people who are new to the stock market and want to begin learning the link between Tavistock Investments PLC (LON:TAVI)’s fundamentals and stock market performance.
Tavistock Investments PLC (LON:TAVI) trades with a trailing P/E of 66.7x, which is higher than the industry average of 16.2x. While this makes TAVI 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. 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 Tavistock Investments
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 dollar of the company’s earnings.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for TAVI
Price per share = £0.031
Earnings per share = £0.000465
∴ Price-Earnings Ratio = £0.031 ÷ £0.000465 = 66.7x
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 TAVI, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use below. 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.
TAVI’s P/E of 66.7x is higher than its industry peers (16.2x), which implies that each dollar of TAVI’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Capital Markets companies in GB including Trading Emissions, Sherborne Investors (Guernsey) B and Argo Group. Therefore, according to this analysis, TAVI is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your TAVI shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to TAVI. 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 TAVI, then TAVI’s P/E would naturally be higher since investors would reward TAVI’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with TAVI, TAVI’s P/E would again be higher since investors would reward TAVI’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing TAVI to are fairly valued by the market. If this assumption is violated, TAVI’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 TAVI. 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 TAVI’s future growth? Take a look at our free research report of analyst consensus for TAVI’s outlook.
- Financial Health: Is TAVI’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.
- 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.