First Real Estate Investment Trust (SGX:AW9U) trades with a trailing P/E of 15.5x, which is lower than the industry average of 15.7x. While this makes AW9U appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for First Real Estate Investment Trust
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 AW9U
Price per share = SGD1.4
Earnings per share = SGD0.09
∴ Price-Earnings Ratio = SGD1.4 ÷ SGD0.09 = 15.5x
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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to AW9U, such as capital structure and profitability. 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.
At 15.5x, AW9U’s P/E is lower than its industry peers (15.7x). This implies that investors are undervaluing each dollar of AW9U’s earnings. As such, our analysis shows that AW9U represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy AW9U 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 AW9U. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing lower risk firms with AW9U, then AW9U’s P/E would naturally be lower than its peers, since investors would value those with lower risk with a higher price. The other possibility is if you were accidentally comparing higher growth firms with AW9U. In this case, AW9U’s P/E would be lower since investors would also reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing AW9U to are fairly valued by the market. If this does not hold, there is a possibility that AW9U’s P/E is lower 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 AW9U 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:
- 1. Future Outlook: What are well-informed industry analysts predicting for AW9U’s future growth? Take a look at our free research report of analyst consensus for AW9U’s outlook.
- 2. Past Track Record: Has AW9U 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 AW9U’s historicals for more clarity.
- 3. 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.