This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
GVC Holdings PLC (LON:GVC) is trading with a trailing P/E of 29.4, which is higher than the industry average of 18. While this might not seem positive, 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.
Check out our latest analysis for GVC Holdings
Demystifying 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 GVC
Price-Earnings Ratio = Price per share ÷ Earnings per share
GVC Price-Earnings Ratio = £9 ÷ £0.306 = 29.4x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to GVC, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 29.4, GVC’s P/E is higher than its industry peers (18). This implies that investors are overvaluing each dollar of GVC’s earnings. This multiple is a median of profitable companies of 25 Hospitality companies in GB including Veltyco Group, C.H. Bailey and Heavitree Brewery. You could think of it like this: the market is pricing GVC as if it is a stronger company than the average of its industry group.
A few caveats
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to GVC. If this isn’t the case, the difference in P/E could be due to other factors. For example, GVC Holdings PLC could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to GVC may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
Since you may have already conducted your due diligence on GVC, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. 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: