This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
UBS Group AG (VTX:UBSG) is currently trading at a trailing P/E of 36.7, which is higher than the industry average of 15.5. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 UBS Group
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 UBSG
Price-Earnings Ratio = Price per share ÷ Earnings per share
UBSG Price-Earnings Ratio = CHF13.86 ÷ CHF0.378 = 36.7x
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 UBSG, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. UBSG’s P/E of 36.7 is higher than its industry peers (15.5), which implies that each dollar of UBSG’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 11 Capital Markets companies in CH including AP Alternative Portfolio, Julius Baer Group and Compagnie Financière Tradition. You could think of it like this: the market is pricing UBSG as if it is a stronger company than the average of its industry group.
A few caveats
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to UBSG. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where UBS Group AG is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with UBSG are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.