Should You Be Tempted To Sell Spire Healthcare Group Plc (LON:SPI) Because Of Its PE Ratio?

Spire Healthcare Group Plc (LSE:SPI) is currently trading at a trailing P/E of 52.5x, which is higher than the industry average of 46.6x. While SPI 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. Check out our latest analysis for Spire Healthcare Group

Breaking down the Price-Earnings 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.

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 SPI, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use below. 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.

SPI’s P/E of 52.5x is higher than its industry peers (46.6x), which implies that each dollar of SPI’s earnings is being overvalued by investors. Therefore, according to this analysis, SPI is an over-priced stock.

Assumptions to watch out for

However, before you rush out to sell your SPI shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to SPI. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing riskier firms with SPI, then SPI’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with SPI. In this case, SPI’s P/E would be higher since investors would also reward SPI’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing SPI to are fairly valued by the market. If this assumption is violated, SPI's P/E may be higher than its peers because its peers are actually undervalued by investors.

What this means for you:

Since you may have already conducted your due diligence on SPI, 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:

1. Future Outlook: What are well-informed industry analysts predicting for SPI’s future growth? Take a look at our free research report of analyst consensus for SPI’s outlook.
2. Past Track Record: Has SPI 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 SPI's historicals for more clarity.
3. 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.

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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.