In This Article:
First Sponsor Group Limited (SGX:ADN) trades with a trailing P/E of 9x, which is lower than the industry average of 9.9x. While ADN 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 First Sponsor Group
What you need to know about 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 ADN
Price-Earnings Ratio = Price per share ÷ Earnings per share
ADN Price-Earnings Ratio = SGD1.27 ÷ SGD0.141 = 9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ADN, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. ADN’s P/E of 9x is lower than its industry peers (9.9x), which implies that each dollar of ADN’s earnings is being undervalued by investors. As such, our analysis shows that ADN represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy ADN, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to ADN. 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 ADN, 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 ADN to are fairly valued by the market. If this does not hold true, ADN’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to ADN. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 highly recommend you to complete your research by taking a look at the following: