What Does AdEPT Telecom plc's (LON:ADT) PE Ratio Tell You?

This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

AdEPT Telecom plc (LON:ADT) trades with a trailing P/E of 21.4x, which is higher than the industry average of 17x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for AdEPT Telecom

Breaking down the Price-Earnings ratio

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.

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 ADT, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will 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.

ADT’s P/E of 21.4x is higher than its industry peers (17x), which implies that each dollar of ADT’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 5 Telecom companies in GB including BT Group, Inmarsat and Manx Telecom. As such, our analysis shows that ADT represents an over-priced stock.

Assumptions to watch out for

While our conclusion might prompt you to sell your ADT shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ADT. 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 ADT, then ADT’s P/E would naturally be higher since investors would reward ADT’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with ADT, ADT’s P/E would again be higher since investors would reward ADT’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing ADT to are fairly valued by the market. If this assumption is violated, ADT's P/E may be higher than its peers because its peers are actually undervalued by investors.

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 ADT. 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 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 ADT’s future growth? Take a look at our free research report of analyst consensus for ADT’s outlook.
2. Past Track Record: Has ADT 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 ADT'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.