This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Gravity Co Ltd (NASDAQ:GRVY) is currently trading at a trailing P/E of 9.9, which is lower than the industry average of 20.7. Although some investors might think this is a real positive, that might change once you understand the assumptions behind the P/E. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Breaking down 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. 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 GRVY
Price per share = ₩25359.94
Earnings per share = ₩2555.519
∴ Price-Earnings Ratio = ₩25359.94 ÷ ₩2555.519 = 9.9x
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 GRVY, such as capital structure and profitability. 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.
GRVY’s P/E of 9.9 is lower than its industry peers (20.7), which implies that each dollar of GRVY’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 23 Entertainment companies in US including Chicken Soup for the Soul Entertainment, Dolphin Entertainment and Viacom. You can think of it like this: the market is suggesting that GRVY is a weaker business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two important assertions. The first is that our peer group actually contains companies that are similar to GRVY. 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 GRVY, then investors would naturally value GRVY at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with GRVY, investors would also value GRVY at a lower price since it is a lower growth investment. Both scenarios would explain why GRVY has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing GRVY to are fairly valued by the market. If this assumption is violated, GRVY’s P/E may be lower than its peers because its peers are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to GRVY. 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 GRVY’s future growth? Take a look at our free research report of analyst consensus for GRVY’s outlook.
- Past Track Record: Has GRVY 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 GRVY’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.