Should You Be Tempted To Buy Marlin Global Limited (NZSE:MLN) Because Of Its PE Ratio?

I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Marlin Global Limited (NZSE:MLN).

Marlin Global Limited (NZSE:MLN) trades with a trailing P/E of 4.4x, which is lower than the industry average of 17.9x. While MLN 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.

What you need to know about the P/E ratio

P/E is a popular ratio used for relative valuation. 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.

Formula

Price-Earnings Ratio = Price per share ÷ Earnings per share

P/E Calculation for MLN

Price per share = NZ\$0.87

Earnings per share = NZ\$0.196

∴ Price-Earnings Ratio = NZ\$0.87 ÷ NZ\$0.196 = 4.4x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as MLN, such as size and country of operation. 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.

At 4.4x, MLN’s P/E is lower than its industry peers (17.9x). This implies that investors are undervaluing each dollar of MLN’s earnings. Therefore, according to this analysis, MLN is an under-priced stock.

A few caveats

However, before you rush out to buy MLN, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to MLN. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with MLN, then investors would naturally value MLN at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with MLN, investors would also value MLN at a lower price since it is a lower growth investment. Both scenarios would explain why MLN has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing MLN to are fairly valued by the market. If this assumption does not hold true, MLN’s lower P/E ratio may be 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 MLN, 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 urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for MLN’s future growth? Take a look at our free research report of analyst consensus for MLN’s outlook.
2. Past Track Record: Has MLN 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 MLN’s historicals for more clarity.
3. 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.