The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Subsea 7 SA (OB:SUBC)’s fundamentals and stock market performance.
Subsea 7 SA (OB:SUBC) trades with a trailing P/E of 16.2x, which is higher than the industry average of 14.7x. 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. View out our latest analysis for Subsea 7
Breaking down the Price-Earnings 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 SUBC
Price per share = $15.09
Earnings per share = $0.930
∴ Price-Earnings Ratio = $15.09 ÷ $0.930 = 16.2x
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 SUBC, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
At 16.2x, SUBC’s P/E is higher than its industry peers (14.7x). This implies that investors are overvaluing each dollar of SUBC’s earnings. Therefore, according to this analysis, SUBC is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your SUBC shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to SUBC. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with SUBC, then SUBC’s P/E would naturally be higher since investors would reward SUBC’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with SUBC, SUBC’s P/E would again be higher since investors would reward SUBC’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing SUBC to are fairly valued by the market. If this assumption does not hold true, SUBC’s higher P/E ratio may be because firms in our peer group are being undervalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to SUBC. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for SUBC’s future growth? Take a look at our free research report of analyst consensus for SUBC’s outlook.
- Past Track Record: Has SUBC 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 SUBC’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.