This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Magseis ASA (OB:MSEIS) is trading with a trailing P/E of 23.3x, which is higher than the industry average of 18.4x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 MSEIS
Price per share = $1.92
Earnings per share = $0.0822
∴ Price-Earnings Ratio = $1.92 ÷ $0.0822 = 23.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to MSEIS, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will 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.
Since MSEIS’s P/E of 23.3x is higher than its industry peers (18.4x), it means that investors are paying more than they should for each dollar of MSEIS’s earnings. This multiple is a median of profitable companies of 8 Energy Services companies in NO including Kværner, Ocean Yield and BW Offshore. As such, our analysis shows that MSEIS represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that MSEIS 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 MSEIS. 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 MSEIS, then MSEIS’s P/E would naturally be higher since investors would reward MSEIS’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with MSEIS, MSEIS’s P/E would again be higher since investors would reward MSEIS’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing MSEIS to are fairly valued by the market. If this assumption does not hold true, MSEIS’s higher P/E ratio may be 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 MSEIS, 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:
- Future Outlook: What are well-informed industry analysts predicting for MSEIS’s future growth? Take a look at our free research report of analyst consensus for MSEIS’s outlook.
- Past Track Record: Has MSEIS 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 MSEIS’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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.