Ormester Vagyonvédelmi Nyrt (BUSE:ORMESTER) is currently trading at a trailing P/E of 45.8x, which is higher than the industry average of 19x. 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. 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 Ormester Vagyonvédelmi Nyrt
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as 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 ORMESTER
Price per share = HUF950
Earnings per share = HUF20.733
∴ Price-Earnings Ratio = HUF950 ÷ HUF20.733 = 45.8x
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. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ORMESTER, such as company lifetime and products sold. 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.
At 45.8x, ORMESTER’s P/E is higher than its industry peers (19x). This implies that investors are overvaluing each dollar of ORMESTER’s earnings. Therefore, according to this analysis, ORMESTER is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your ORMESTER shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to ORMESTER. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with ORMESTER, then ORMESTER’s P/E would naturally be higher since investors would reward ORMESTER’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with ORMESTER, ORMESTER’s P/E would again be higher since investors would reward ORMESTER’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing ORMESTER to are fairly valued by the market. If this does not hold, there is a possibility that ORMESTER’s P/E is higher because firms in our peer group are being undervalued by the market.
What this means for you:
Since you may have already conducted your due diligence on ORMESTER, 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:
- Financial Health: Is ORMESTER’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.
- 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.