KoganCom Limited (ASX:KGN) is trading with a trailing P/E of 110.5x, which is higher than the industry average of 27.6x. 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 explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Kogan.Com
Breaking down the P/E 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 KGN
Price-Earnings Ratio = Price per share ÷ Earnings per share
KGN Price-Earnings Ratio = 4.5 ÷ 0.041 = 110.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 KGN, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 110.5x, KGN’s P/E is higher than its industry peers (27.6x). This implies that investors are overvaluing each dollar of KGN’s earnings. Therefore, according to this analysis, KGN is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that KGN should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to KGN, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with KGN, 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 KGN to are fairly valued by the market. If this is violated, KGN'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 rebalance your portfolio and reduce your holdings in KGN. 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 KGN, 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.