Goals Soccer Centres plc (AIM:GOAL) is currently trading at a trailing P/E of 31.6x, which is higher than the industry average of 22.3x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. 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. Check out our latest analysis for Goals Soccer Centres
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 pound of the company’s earnings.
P/E Calculation for GOAL
Price-Earnings Ratio = Price per share ÷ Earnings per share
GOAL Price-Earnings Ratio = 0.9 ÷ 0.029 = 31.6x
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 GOAL, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. GOAL’s P/E of 31.6x is higher than its industry peers (22.3x), which implies that each dollar of GOAL’s earnings is being overvalued by investors. Therefore, according to this analysis, GOAL is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your GOAL shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to GOAL, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with GOAL, 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 GOAL to are fairly valued by the market. If this does not hold, there is a possibility that GOAL’s P/E is lower because our peer group is overvalued by the market.
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 rebalance your portfolio and reduce your holdings in GOAL. 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 GOAL has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.