Saga Tankers Asa (OB:SAGA) trades with a trailing P/E of 9.7x, which is lower than the industry average of 13.7x. While SAGA 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. Check out our latest analysis for Saga Tankers
Demystifying the P/E 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 SAGA
Price per share = NOK2.08
Earnings per share = NOK0.214
∴ Price-Earnings Ratio = NOK2.08 ÷ NOK0.214 = 9.7x
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 SAGA, 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.
Since SAGA's P/E of 9.7x is lower than its industry peers (13.7x), it means that investors are paying less than they should for each dollar of SAGA's earnings. Therefore, according to this analysis, SAGA is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy SAGA, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to SAGA. 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 SAGA, then SAGA’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 SAGA. In this case, SAGA’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 SAGA to are fairly valued by the market. If this assumption is violated, SAGA's P/E may be lower than its peers because its peers are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to SAGA. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 urge you to complete your research by taking a look at the following:
- Financial Health: Is SAGA’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 SAGA 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 SAGA'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.
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.