The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Wilmar International Limited (SGX:F34) is currently trading at a trailing P/E of 13.7x, which is lower than the industry average of 15.9x. While this makes F34 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.
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in 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 F34
Price per share = $2.34
Earnings per share = $0.171
∴ Price-Earnings Ratio = $2.34 ÷ $0.171 = 13.7x
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 F34, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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.
F34’s P/E of 13.7x is lower than its industry peers (15.9x), which implies that each dollar of F34’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 16 Food companies in SG including Oceanus Group, Fraser and Neave and Sino Grandness Food Industry Group. Therefore, according to this analysis, F34 is an under-priced stock.
A few caveats
Before you jump to the conclusion that F34 represents the perfect buying opportunity, 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 F34. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with F34, then investors would naturally value F34 at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with F34, investors would also value F34 at a lower price since it is a lower growth investment. Both scenarios would explain why F34 has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing F34 to are fairly valued by the market. If this assumption is violated, F34’s P/E may be lower than its peers because its peers are actually overvalued 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 add more of F34 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for F34’s future growth? Take a look at our free research report of analyst consensus for F34’s outlook.
- Past Track Record: Has F34 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 F34’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.