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Gambero Rosso SpA (BIT:GAMB) trades with a trailing P/E of 23.3x, which is higher than the industry average of 21.8x. While GAMB 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Gambero Rosso
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 GAMB
Price-Earnings Ratio = Price per share ÷ Earnings per share
GAMB Price-Earnings Ratio = €1.06 ÷ €0.045 = 23.3x
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 GAMB, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since GAMB’s P/E of 23.3x is higher than its industry peers (21.8x), it means that investors are paying more than they should for each dollar of GAMB’s earnings. As such, our analysis shows that GAMB represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that GAMB 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 GAMB. 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 GAMB, 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 GAMB to are fairly valued by the market. If this does not hold, there is a possibility that GAMB’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.