Clime Investment Management Limited (ASX:CIW) is currently trading at a trailing P/E of 9.9x, which is lower than the industry average of 21.7x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for CIW
Demystifying 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.
P/E Calculation for CIW
Price-Earnings Ratio = Price per share ÷ Earnings per share
CIW Price-Earnings Ratio = 0.52 ÷ 0.052 = 9.9x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to CIW, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 9.9x, CIW’s P/E is lower than its industry peers (21.7x). This implies that investors are undervaluing each dollar of CIW’s earnings. As such, our analysis shows that CIW represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy CIW, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CIW. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with CIW, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CIW to are fairly valued by the market. If this does not hold true, CIW’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? 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 CIW 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.
Are you a potential investor? If you are considering investing in CIW, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.