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Agfa-Gevaert NV (ENXTBR:AGFB) trades with a trailing P/E of 14.3x, which is lower than the industry average of 35.9x. While this makes AGFB appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Agfa-Gevaert
What you need to know about the P/E ratio
P/E is a popular ratio used for 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 AGFB
Price-Earnings Ratio = Price per share ÷ Earnings per share
AGFB Price-Earnings Ratio = €3.15 ÷ €0.221 = 14.3x
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 AGFB, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. AGFB’s P/E of 14.3x is lower than its industry peers (35.9x), which implies that each dollar of AGFB’s earnings is being undervalued by investors. As such, our analysis shows that AGFB represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that AGFB 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 AGFB. 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 AGFB, 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 AGFB to are fairly valued by the market. If this does not hold true, AGFB’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.