Intertrust NV. (ENXTAM:INTER) is trading with a trailing P/E of 17.4x, which is lower than the industry average of 17.7x. While this makes INTER appear like a great stock to buy, 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. See our latest analysis for Intertrust

What you need to know about the P/E ratio

P/E is often used for relative valuation since earnings power is a chief 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.

P/E Calculation for INTER

Price-Earnings Ratio = Price per share ÷ Earnings per share

INTER Price-Earnings Ratio = €16.84 ÷ €0.97 = 17.4x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 INTER, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 17.4x, INTER’s P/E is lower than its industry peers (17.7x). This implies that investors are undervaluing each dollar of INTER’s earnings. Therefore, according to this analysis, INTER is an under-priced stock.

Assumptions to watch out for

However, before you rush out to buy INTER, 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 INTER, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with INTER, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing INTER to are fairly valued by the market. If this does not hold true, INTER’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

To help readers see pass 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.