This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.
Public Stock Company VSMPO-AVISMA Corporation (MCX:VSMO) is currently trading at a trailing P/E of 14.5x, which is higher than the industry average of 5.5x. While VSMO might seem like a stock to avoid or sell if you own it, 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.
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 VSMO
Price per share = RUB16190
Earnings per share = RUB1114.84
∴ Price-Earnings Ratio = RUB16190 ÷ RUB1114.84 = 14.5x
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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as VSMO, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use below. 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.
Since VSMO’s P/E of 14.5x is higher than its industry peers (5.5x), it means that investors are paying more than they should for each dollar of VSMO’s earnings. This multiple is a median of profitable companies of 22 Metals and Mining companies in RU including En+ Group, Urals Stampings Plant PAO and Chelyabinsk Metallurgical Plant PAO. As such, our analysis shows that VSMO represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that VSMO should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to VSMO. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with VSMO, then VSMO’s P/E would naturally be higher since investors would reward VSMO’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with VSMO, VSMO’s P/E would again be higher since investors would reward VSMO’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing VSMO to are fairly valued by the market. If this assumption does not hold true, VSMO’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 VSMO. 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:
- Future Outlook: What are well-informed industry analysts predicting for VSMO’s future growth? Take a look at our free research report of analyst consensus for VSMO’s outlook.
- Past Track Record: Has VSMO 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 VSMO’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.