Fliway Group Limited (NZSE:FLI) is trading with a trailing P/E of 12x, which is lower than the industry average of 26.3x. While FLI 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for FLI
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 FLI
Price-Earnings Ratio = Price per share ÷ Earnings per share
FLI Price-Earnings Ratio = 1.03 ÷ 0.086 = 12x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as FLI, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 12x, FLI’s P/E is lower than its industry peers (26.3x). This implies that investors are undervaluing each dollar of FLI’s earnings. Therefore, according to this analysis, FLI is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy FLI immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to FLI, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with FLI, 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 FLI to are fairly valued by the market. If this is violated, FLI's P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of FLI to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in FLI, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.