LillestrømBanken (OB:LSTSB-ME) is currently trading at a trailing P/E of 1.7x, which is lower than the industry average of 8.9x. While LSTSB-ME might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for LillestrømBanken
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 LSTSB-ME
Price per share = NOK106
Earnings per share = NOK63.355
∴ Price-Earnings Ratio = NOK106 ÷ NOK63.355 = 1.7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 LSTSB-ME, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. 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 1.7x, LSTSB-ME’s P/E is lower than its industry peers (8.9x). This implies that investors are undervaluing each dollar of LSTSB-ME’s earnings. As such, our analysis shows that LSTSB-ME represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy LSTSB-ME 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 LSTSB-ME. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with LSTSB-ME, then LSTSB-ME’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with LSTSB-ME, LSTSB-ME’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing LSTSB-ME to are fairly valued by the market. If this assumption is violated, LSTSB-ME’s P/E may be lower than its peers because its peers are actually overvalued 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 add more of LSTSB-ME to your portfolio. 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:
- Financial Health: Is LSTSB-ME’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.
- Past Track Record: Has LSTSB-ME 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 LSTSB-ME’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.