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This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Inwido AB (STO:INWI) is trading with a trailing P/E of 11.6x, which is lower than the industry average of 18x. While INWI 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
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Breaking down the Price-Earnings 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 INWI
Price-Earnings Ratio = Price per share ÷ Earnings per share
INWI Price-Earnings Ratio = SEK58.65 ÷ SEK5.068 = 11.6x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as INWI, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since INWI’s P/E of 11.6 is lower than its industry peers (18), it means that investors are paying less for each dollar of INWI’s earnings. This multiple is a median of profitable companies of 11 Building companies in SE including Nordic Waterproofing Holding, Svedbergs i Dalstorp and Lindab International. One could put it like this: the market is pricing INWI as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, 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 INWI, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with INWI, 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 INWI to are fairly valued by the market. If this does not hold true, INWI’s lower P/E ratio may be because firms in our peer group are overvalued by the market.