In This Article:
This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Wihlborgs Fastigheter AB (publ) (STO:WIHL) is trading with a trailing P/E of 6.2x, which is lower than the industry average of 7.3x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. 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 Wihlborgs Fastigheter
Breaking down the Price-Earnings 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 WIHL
Price-Earnings Ratio = Price per share ÷ Earnings per share
WIHL Price-Earnings Ratio = SEK104.14 ÷ SEK16.908 = 6.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to WIHL, 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. At 6.2, WIHL’s P/E is lower than its industry peers (7.3). This implies that investors are undervaluing each dollar of WIHL’s earnings. This multiple is a median of profitable companies of 24 Real Estate companies in SE including Aktiebolaget Fastator, Kallebäck Property Invest and Corem Property Group. You can think of it like this: the market is suggesting that WIHL is a weaker business than the average comparable company.
A few caveats
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to WIHL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with WIHL, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing WIHL to are fairly valued by the market. If this is violated, WIHL’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on WIHL, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. 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 urge you to complete your research by taking a look at the following: