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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.
Derichebourg (EPA:DBG) trades with a trailing P/E of 8.3x, which is lower than the industry average of 14.9x. While DBG 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. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
See our latest analysis for Derichebourg
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 DBG
Price-Earnings Ratio = Price per share ÷ Earnings per share
DBG Price-Earnings Ratio = €4.02 ÷ €0.484 = 8.3x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to DBG, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 8.3, DBG’s P/E is lower than its industry peers (14.9). This implies that investors are undervaluing each dollar of DBG’s earnings. This multiple is a median of profitable companies of 12 Commercial Services companies in FR including Groupe Pizzorno Environnement, Constructions Industrielles de la Méditerranée and Séché Environnement. You can think of it like this: the market is suggesting that DBG is a weaker business than the average comparable company.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to DBG, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with DBG, 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 DBG to are fairly valued by the market. If this does not hold, there is a possibility that DBG’s P/E is lower because our peer group is overvalued by the market.