The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
DNXCorp SE (EPA:DNX) trades with a trailing P/E of 6.4x, which is lower than the industry average of 22.7x. While DNX 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 DNXCorp
Breaking down the Price-Earnings 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 DNX
Price-Earnings Ratio = Price per share ÷ Earnings per share
DNX Price-Earnings Ratio = €6.38 ÷ €0.993 = 6.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to DNX, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since DNX’s P/E of 6.4 is lower than its industry peers (22.7), it means that investors are paying less for each dollar of DNX’s earnings. Since the Interactive Media and Services sector in FR is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as AudioValley, Acheter-Louer.Fr and auFeminin.com. You can think of it like this: the market is suggesting that DNX is a weaker business than the average comparable company.
A few caveats
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to DNX, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with DNX, 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 DNX to are fairly valued by the market. If this is violated, DNX’s P/E may be lower than its peers as they are actually overvalued by investors.