Yellow Brick Road Holdings Limited (ASX:YBR) is trading with a trailing P/E of 41.8x, which is higher than the industry average of 19.7x. While this makes YBR 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. In this article, 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 Yellow Brick Road Holdings
Demystifying the P/E 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 YBR
Price-Earnings Ratio = Price per share ÷ Earnings per share
YBR Price-Earnings Ratio = A$0.13 ÷ A$0.003 = 41.8x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as YBR, 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. YBR’s P/E of 41.8x is higher than its industry peers (19.7x), which implies that each dollar of YBR’s earnings is being overvalued by investors. Therefore, according to this analysis, YBR is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that YBR should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to YBR. 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 YBR, 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 YBR to are fairly valued by the market. If this does not hold, there is a possibility that YBR’s P/E is lower because our peer group is 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.