Phileo Australia Limited (ASX:PHI) is currently trading at a trailing P/E of 14.2x, which is higher than the industry average of 11.4x. While PHI might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 Phileo Australia
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 PHI
Price-Earnings Ratio = Price per share ÷ Earnings per share
PHI Price-Earnings Ratio = A$11.52 ÷ A$0.809 = 14.2x
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 PHI, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. PHI’s P/E of 14.2x is higher than its industry peers (11.4x), which implies that each dollar of PHI’s earnings is being overvalued by investors. As such, our analysis shows that PHI represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your PHI shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to PHI, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with PHI, 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 PHI to are fairly valued by the market. If this does not hold true, PHI’s lower P/E ratio may be because firms in our peer group are overvalued 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.