Does Dart Group PLC's (LON:DTG) PE Ratio Signal A Selling Opportunity?

Dart Group PLC (AIM:DTG) is trading with a trailing P/E of 8.8x, which is higher than the industry average of 8.7x. While this makes DTG appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, 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 Dart Group

Breaking down the Price-Earnings ratio

The P/E ratio is one of many ratios used in 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.

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 DTG, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.

DTG’s P/E of 8.8x is higher than its industry peers (8.7x), which implies that each dollar of DTG’s earnings is being overvalued by investors. Therefore, according to this analysis, DTG is an over-priced stock.

A few caveats

Before you jump to the conclusion that DTG 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 DTG. 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 DTG, then investors would naturally value DTG at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with DTG, investors would also value DTG at a higher price since it is a higher growth investment. Both scenarios would explain why DTG has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing DTG to are fairly valued by the market. If this assumption is violated, DTG'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 DTG. 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. Financial Health: Is DTG’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 DTG 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 DTG'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

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.