Public Joint Stock Company Territorial Generation Company No 14 (MISX:TGKN) is trading with a trailing P/E of 20.2x, which is higher than the industry average of 6.4x. While this makes TGKN appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Territorial Generation Company No. 14
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as 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 TGKN
Price per share = RUB0.01
Earnings per share = RUB0
∴ Price-Earnings Ratio = RUB0.01 ÷ RUB0 = 20.2x
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 TGKN, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
Since TGKN’s P/E of 20.2x is higher than its industry peers (6.4x), it means that investors are paying more than they should for each dollar of TGKN’s earnings. Therefore, according to this analysis, TGKN is an over-priced stock.
A few caveats
Before you jump to the conclusion that TGKN should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to TGKN. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared riskier firms with TGKN, then investors would naturally value TGKN at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with TGKN, investors would also value TGKN at a higher price since it is a higher growth investment. Both scenarios would explain why TGKN has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing TGKN to are fairly valued by the market. If this assumption is violated, TGKN’s P/E may be higher than its peers because its peers are actually undervalued by investors.
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 rebalance your portfolio and reduce your holdings in TGKN. 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 highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is TGKN’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 TGKN 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 TGKN’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.