This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Apollo Global Management LLC (NYSE:APO) trades with a trailing P/E of 17.7x, which is higher than the industry average of 16x. While this makes APO 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down the P/E ratio
P/E is a popular ratio used for relative valuation. 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 APO
Price per share = $35.38
Earnings per share = $1.995
∴ Price-Earnings Ratio = $35.38 ÷ $1.995 = 17.7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to APO, such as capital structure and profitability. 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.
APO’s P/E of 17.7x is higher than its industry peers (16x), which implies that each dollar of APO’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Capital Markets companies in US including Modern Technology, Neon Capital and Oracle Healthcare Acquisition. As such, our analysis shows that APO represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your APO shares, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to APO. 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 APO, then APO’s P/E would naturally be higher since investors would reward APO’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with APO, APO’s P/E would again be higher since investors would reward APO’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing APO to are fairly valued by the market. If this assumption does not hold true, APO’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 APO. 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:
- Future Outlook: What are well-informed industry analysts predicting for APO’s future growth? Take a look at our free research report of analyst consensus for APO’s outlook.
- Past Track Record: Has APO 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 APO’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 email@example.com.