Should You Be Tempted To Buy Schroder Real Estate Investment Trust Limited (LON:SREI) Because Of Its PE Ratio?

Schroder Real Estate Investment Trust Limited (LSE:SREI) is currently trading at a trailing P/E of 8.5x, which is lower than the industry average of 10.9x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Schroder Real Estate Investment Trust

Breaking down the P/E ratio

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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.

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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SREI, such as size and country of operation. 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.

At 8.5x, SREI’s P/E is lower than its industry peers (10.9x). This implies that investors are undervaluing each dollar of SREI’s earnings. Therefore, according to this analysis, SREI is an under-priced stock.

Assumptions to watch out for

While our conclusion might prompt you to buy SREI immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to SREI. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with SREI, then investors would naturally value SREI at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with SREI, investors would also value SREI at a lower price since it is a lower growth investment. Both scenarios would explain why SREI has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing SREI to are fairly valued by the market. If this does not hold, there is a possibility that SREI’s P/E is lower because firms in our peer group are being overvalued by the market.

What this means for you:

Since you may have already conducted your due diligence on SREI, the undervaluation of the stock may mean it is a good time to top up on 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. Financial Health: Is SREI’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.

2. Past Track Record: Has SREI 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 SREI'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.