The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to learn about the link between company’s fundamentals and stock market performance.
STEICO SE (FRA:ST5) is trading with a trailing P/E of 22.5x, which is higher than the industry average of 21.2x. While this makes ST5 appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for STEICO
What you need to know about the P/E ratio
P/E is a popular ratio used for relative valuation. 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 ST5
Price-Earnings Ratio = Price per share ÷ Earnings per share
ST5 Price-Earnings Ratio = €24.4 ÷ €1.084 = 22.5x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to ST5, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 22.5x, ST5’s P/E is higher than its industry peers (21.2x). This implies that investors are overvaluing each dollar of ST5’s earnings. This multiple is a median of profitable companies of 25 Building companies in DE including Safestyle UK, China Lesso Group Holdings and InnoTec TSS. Therefore, according to this analysis, ST5 is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your ST5 shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to ST5. 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 ST5, 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 ST5 to are fairly valued by the market. If this does not hold true, ST5’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to ST5. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following: