Fresenius SE & Co KGaA (DB:FRE) is trading with a trailing P/E of 20.3x, which is lower than the industry average of 21.2x. While FRE 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. In this article, 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 Fresenius SE KGaA

Breaking down the Price-Earnings ratio

P/E is a popular ratio used for relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.

P/E Calculation for FRE

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

FRE Price-Earnings Ratio = €65.5 ÷ €3.22 = 20.3x

On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as FRE, 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. At 20.3x, FRE’s P/E is lower than its industry peers (21.2x). This implies that investors are undervaluing each dollar of FRE’s earnings. As such, our analysis shows that FRE represents an under-priced stock.

A few caveats

While our conclusion might prompt you to buy FRE immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to FRE. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with FRE, 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 FRE to are fairly valued by the market. If this is violated, FRE’s P/E may be lower than its peers as they are actually overvalued by investors.

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.