I am writing today to help inform people who are new to the stock market and want to begin learning the link between Surnadal Sparebank AS (OB:SUSB-ME)’s fundamentals and stock market performance.
Surnadal Sparebank AS (OB:SUSB-ME) trades with a trailing P/E of 1.4x, which is lower than the industry average of 9.1x. While this makes SUSB-ME appear like a great stock to buy, 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 out our latest analysis for Surnadalrebank
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 SUSB-ME
Price per share = NOK108
Earnings per share = NOK76.38
∴ Price-Earnings Ratio = NOK108 ÷ NOK76.38 = 1.4x
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 SUSB-ME, 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 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 1.4x, SUSB-ME’s P/E is lower than its industry peers (9.1x). This implies that investors are undervaluing each dollar of SUSB-ME’s earnings. This multiple is a median of profitable companies of 24 Banks companies in NO including Sparebank 1 Nordvest, LillestrømBanken and Surnadalrebank. As such, our analysis shows that SUSB-ME represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy SUSB-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 SUSB-ME. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing lower risk firms with SUSB-ME, then SUSB-ME’s P/E would naturally be lower than its peers, since investors would value those with lower risk with a higher price. The other possibility is if you were accidentally comparing higher growth firms with SUSB-ME. In this case, SUSB-ME’s P/E would be lower since investors would also reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing SUSB-ME to are fairly valued by the market. If this does not hold, there is a possibility that SUSB-ME’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 SUSB-ME, 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:
- Future Outlook: What are well-informed industry analysts predicting for SUSB-ME’s future growth? Take a look at our free research report of analyst consensus for SUSB-ME’s outlook.
- Financial Health: Is SUSB-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.
- 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.