Vita Group Limited (ASX:VTG) is currently trading at a trailing P/E of 6.2x, which is lower than the industry average of 15.4x. While VTG 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 Vita Group
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 VTG
Price-Earnings Ratio = Price per share ÷ Earnings per share
VTG Price-Earnings Ratio = A$1.17 ÷ A$0.188 = 6.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to VTG, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since VTG’s P/E of 6.2x is lower than its industry peers (15.4x), it means that investors are paying less than they should for each dollar of VTG’s earnings. As such, our analysis shows that VTG represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy VTG immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to VTG. 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 VTG, 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 VTG to are fairly valued by the market. If this does not hold, there is a possibility that VTG’s P/E is lower because our peer group is overvalued by the market.
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 VTG. 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: