I am writing today to help inform people who are new to the stock market and want to begin learning the link between Sociedad Química y Minera de Chile SA (NYSE:SQM)’s fundamentals and stock market performance.
Sociedad Química y Minera de Chile SA (NYSE:SQM) trades with a trailing P/E of 29.5x, which is higher than the industry average of 16.5x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. View out our latest analysis for Sociedad Química y Minera de Chile
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 SQM
Price per share = $49.18
Earnings per share = $1.665
∴ Price-Earnings Ratio = $49.18 ÷ $1.665 = 29.5x
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 SQM, 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 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 SQM’s P/E of 29.5x is higher than its industry peers (16.5x), it means that investors are paying more than they should for each dollar of SQM’s earnings. As such, our analysis shows that SQM represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your SQM shares 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 SQM. 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 SQM, then SQM’s P/E would naturally be higher since investors would reward SQM’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with SQM, SQM’s P/E would again be higher since investors would reward SQM’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing SQM to are fairly valued by the market. If this assumption is violated, SQM’s P/E may be higher than its peers because its peers are actually undervalued by investors.
What this means for you:
Since you may have already conducted your due diligence on SQM, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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:
- Future Outlook: What are well-informed industry analysts predicting for SQM’s future growth? Take a look at our free research report of analyst consensus for SQM’s outlook.
- Past Track Record: Has SQM 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 SQM’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.