This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Impexmetal SA (WSE:IPX) is currently trading at a trailing P/E of 9.3x, which is lower than the industry average of 9.9x. While IPX 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for IPX
Price per share = PLN3.99
Earnings per share = PLN0.429
∴ Price-Earnings Ratio = PLN3.99 ÷ PLN0.429 = 9.3x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to IPX, such as company lifetime and products sold. 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.
IPX’s P/E of 9.3x is lower than its industry peers (9.9x), which implies that each dollar of IPX’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 14 Metals and Mining companies in PL including Konsorcjum Stali, Jastrzebska Spólka Weglowa and Cognor Holding. As such, our analysis shows that IPX represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy IPX immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to IPX. 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 IPX, then investors would naturally value IPX at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with IPX, investors would also value IPX at a lower price since it is a lower growth investment. Both scenarios would explain why IPX has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing IPX to are fairly valued by the market. If this assumption does not hold true, IPX’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of IPX to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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:
- Future Outlook: What are well-informed industry analysts predicting for IPX’s future growth? Take a look at our free research report of analyst consensus for IPX’s outlook.
- Past Track Record: Has IPX 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 IPX’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.