Iliad SA (ENXTPA:ILD) is currently trading at a trailing P/E of 19.5x, which is lower than the industry average of 20x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Iliad
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 ILD
Price-Earnings Ratio = Price per share ÷ Earnings per share
ILD Price-Earnings Ratio = €131.95 ÷ €6.761 = 19.5x
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 ILD, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 19.5x, ILD’s P/E is lower than its industry peers (20x). This implies that investors are undervaluing each dollar of ILD’s earnings. As such, our analysis shows that ILD represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that ILD is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to ILD. 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 ILD, 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 ILD to are fairly valued by the market. If this does not hold, there is a possibility that ILD’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of ILD to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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: