Sunland Group Limited (ASX:SDG) is currently trading at a trailing P/E of 7.4x, which is lower than the industry average of 11.6x. While SDG 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. See our latest analysis for SDG
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in 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 SDG
Price-Earnings Ratio = Price per share ÷ Earnings per share
SDG Price-Earnings Ratio = 1.65 ÷ 0.224 = 7.4x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SDG, 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. At 7.4x, SDG’s P/E is lower than its industry peers (11.6x). This implies that investors are undervaluing each dollar of SDG’s earnings. Therefore, according to this analysis, SDG is an under-priced stock.
A few caveats
Before you jump to the conclusion that SDG is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to SDG, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with SDG, 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 SDG to are fairly valued by the market. If this does not hold, there is a possibility that SDG’s P/E is lower because our peer group is overvalued by the market.
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 add more of SDG to your portfolio. 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 SDG, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.