Zenitas Healthcare Limited (ASX:ZNT) is currently trading at a trailing P/E of 32x, which is higher than the industry average of 21.4x. While ZNT might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 Zenitas Healthcare

What you need to know about the P/E 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 ZNT

Price-Earnings Ratio = Price per share ÷ Earnings per share

ZNT Price-Earnings Ratio = A$1.17 ÷ A$0.037 = 32x

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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to ZNT, 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. ZNT’s P/E of 32x is higher than its industry peers (21.4x), which implies that each dollar of ZNT’s earnings is being overvalued by investors. Therefore, according to this analysis, ZNT is an over-priced stock.

A few caveats

While our conclusion might prompt you to sell your ZNT shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ZNT, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with ZNT, 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 ZNT to are fairly valued by the market. If this does not hold true, ZNT’s lower P/E ratio may be because firms in our peer group are 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.