Shaver Shop Group Limited (ASX:SSG) is currently trading at a trailing P/E of 6.1x, which is lower than the industry average of 14.6x. While SSG 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Shaver Shop Group
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in 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 SSG
Price-Earnings Ratio = Price per share ÷ Earnings per share
SSG Price-Earnings Ratio = 0.44 ÷ 0.072 = 6.1x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SSG, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 6.1x, SSG’s P/E is lower than its industry peers (14.6x). This implies that investors are undervaluing each dollar of SSG’s earnings. As such, our analysis shows that SSG represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy SSG immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to SSG. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with SSG, 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 SSG to are fairly valued by the market. If this is violated, SSG's P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on SSG, the undervaluation of the stock may mean it is a good time to top up on 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.
Are you a potential investor? If you are considering investing in SSG, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.