Avangard Joint Stock BANK (MISX:AVAN) is currently trading at a trailing P/E of 3.4x, which is lower than the industry average of 6.5x. While this makes AVAN appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Avangard BANK
What you need to know about the P/E 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 AVAN
Price per share = RUB483
Earnings per share = RUB140.624
∴ Price-Earnings Ratio = RUB483 ÷ RUB140.624 = 3.4x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against 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 AVAN, 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.
At 3.4x, AVAN’s P/E is lower than its industry peers (6.5x). This implies that investors are undervaluing each dollar of AVAN’s earnings. As such, our analysis shows that AVAN represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy AVAN immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to AVAN. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with AVAN, then AVAN’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with AVAN, AVAN’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing AVAN to are fairly valued by the market. If this does not hold, there is a possibility that AVAN’s P/E is lower because firms in our peer group are being overvalued by the market.
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 AVAN. 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:
- Financial Health: Is AVAN’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 AVAN 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 AVAN’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.