Jenoptik AG (XTRA:JEN) is trading with a trailing P/E of 25.8x, which is higher than the industry average of 21.4x. 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Jenoptik

Breaking down the Price-Earnings ratio

P/E is a popular ratio used for relative valuation. 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 dollar of the company’s earnings.

P/E Calculation for JEN

Price-Earnings Ratio = Price per share ÷ Earnings per share

JEN Price-Earnings Ratio = €28.02 ÷ €1.086 = 25.8x

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. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as JEN, 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. Since JEN’s P/E of 25.8x is higher than its industry peers (21.4x), it means that investors are paying more than they should for each dollar of JEN’s earnings. Therefore, according to this analysis, JEN is an over-priced stock.

Assumptions to watch out for

While our conclusion might prompt you to sell your JEN shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to JEN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with JEN, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing JEN to are fairly valued by the market. If this does not hold, there is a possibility that JEN’s P/E is lower because our peer group is overpriced 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.