Story-I Limited (ASX:SRY) trades with a trailing P/E of 4.5x, which is lower than the industry average of 14.5x. While SRY might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Story-I
What you need to know about 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.
P/E Calculation for SRY
Price-Earnings Ratio = Price per share ÷ Earnings per share
SRY Price-Earnings Ratio = 0.03 ÷ 0.007 = 4.5x
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 SRY, 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 SRY's P/E of 4.5x is lower than its industry peers (14.5x), it means that investors are paying less than they should for each dollar of SRY's earnings. Therefore, according to this analysis, SRY is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy SRY, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to SRY, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with SRY, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing SRY to are fairly valued by the market. If this is violated, SRY's P/E may be lower than its peers as they are actually expensive by investors.
What this means for you:
Are you a shareholder? 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 SRY. 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.
Are you a potential investor? If SRY has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.