Alchemia SA. (WSE:ALC) is currently trading at a trailing P/E of 103x, which is higher than the industry average of 10.7x. While this makes ALC appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Alchemia
What you need to know about the P/E 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 ALC
Price-Earnings Ratio = Price per share ÷ Earnings per share
ALC Price-Earnings Ratio = PLN4.2 ÷ PLN0.041 = 103x
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 ALC, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 103x, ALC’s P/E is higher than its industry peers (10.7x). This implies that investors are overvaluing each dollar of ALC’s earnings. As such, our analysis shows that ALC represents an over-priced stock.
A few caveats
However, before you rush out to sell your ALC shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to ALC. 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 ALC, 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 ALC to are fairly valued by the market. If this does not hold, there is a possibility that ALC’s P/E is lower because our peer group is 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.