Advanced Share Registry Limited (ASX:ASW) is currently trading at a trailing P/E of 19.1x, which is lower than the industry average of 20x. 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. View our latest analysis for Advanced Share Registry

Breaking down the Price-Earnings 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 ASW

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

ASW Price-Earnings Ratio = A$0.76 ÷ A$0.04 = 19.1x

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 ASW, 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. ASW’s P/E of 19.1x is lower than its industry peers (20x), which implies that each dollar of ASW’s earnings is being undervalued by investors. As such, our analysis shows that ASW represents an under-priced stock.

Assumptions to watch out for

Before you jump to the conclusion that ASW is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to ASW. 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 ASW, 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 ASW to are fairly valued by the market. If this does not hold true, ASW’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.