This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Huntsworth plc (LON:HNT).
Huntsworth plc (LON:HNT) trades with a trailing P/E of 24x, which is higher than the industry average of 23x. While HNT 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Huntsworth
Demystifying 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 HNT
Price per share = £1.15
Earnings per share = £0.0479
∴ Price-Earnings Ratio = £1.15 ÷ £0.0479 = 24x
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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to HNT, such as capital structure and profitability. 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.
HNT’s P/E of 24x is higher than its industry peers (23x), which implies that each dollar of HNT’s earnings is being overvalued by investors. Therefore, according to this analysis, HNT is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that HNT should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to HNT. 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 HNT, then investors would naturally value HNT at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with HNT, investors would also value HNT at a higher price since it is a higher growth investment. Both scenarios would explain why HNT has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing HNT to are fairly valued by the market. If this does not hold, there is a possibility that HNT’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 HNT. 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 HNT’s future growth? Take a look at our free research report of analyst consensus for HNT’s outlook.
- Past Track Record: Has HNT 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 HNT’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.