Is London Stock Exchange Group plc (LON:LSE) A Sell At Its Current PE Ratio?

By
Simply Wall St
Published
January 23, 2018
LSE:LSEG
Source: Shutterstock

London Stock Exchange Group plc (LSE:LSE) is trading with a trailing P/E of 43.7x, which is higher than the industry average of 17.7x. While LSE might seem like a stock to avoid or sell if you own it, 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. View our latest analysis for London Stock Exchange Group

Breaking down the Price-Earnings ratio

LSE:LSE PE PEG Gauge Jan 24th 18
LSE:LSE PE PEG Gauge Jan 24th 18

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 pound of the company’s earnings.

Formula

Price-Earnings Ratio = Price per share ÷ Earnings per share

P/E Calculation for LSE

Price per share = £37.99

Earnings per share = £0.869

∴ Price-Earnings Ratio = £37.99 ÷ £0.869 = 43.7x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to LSE, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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.

LSE’s P/E of 43.7x is higher than its industry peers (17.7x), which implies that each dollar of LSE’s earnings is being overvalued by investors. Therefore, according to this analysis, LSE is an over-priced stock.

Assumptions to be aware of

Before you jump to the conclusion that LSE should be banished from your portfolio, 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 LSE. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with LSE, then investors would naturally value LSE at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with LSE, investors would also value LSE at a higher price since it is a higher growth investment. Both scenarios would explain why LSE has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing LSE to are fairly valued by the market. If this assumption does not hold true, LSE’s higher P/E ratio may be because firms in our peer group are being undervalued by the market.

LSE:LSE Future Profit Jan 24th 18
LSE:LSE Future Profit Jan 24th 18

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 rebalance your portfolio and reduce your holdings in LSE. 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 urge you to complete your research by taking a look at the following:

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.

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