Intershop Holding AG (SWX:ISN) trades with a trailing P/E of 15.8x, which is higher than the industry average of 13.5x. While ISN 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Intershop Holding
Breaking down 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 ISN
Price-Earnings Ratio = Price per share ÷ Earnings per share
ISN Price-Earnings Ratio = CHF502 ÷ CHF31.762 = 15.8x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as ISN, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 15.8x, ISN’s P/E is higher than its industry peers (13.5x). This implies that investors are overvaluing each dollar of ISN’s earnings. As such, our analysis shows that ISN represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your ISN shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ISN, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with ISN, 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 ISN to are fairly valued by the market. If this does not hold, there is a possibility that ISN’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.