In This Article:
I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Neopost SA (EPA:NEO) is trading with a trailing P/E of 7.3x, which is lower than the industry average of 11.7x. While NEO 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.
Check out our latest analysis for Neopost
What you need to know about 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 NEO
Price-Earnings Ratio = Price per share ÷ Earnings per share
NEO Price-Earnings Ratio = €28.32 ÷ €3.896 = 7.3x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 NEO, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. NEO’s P/E of 7.3 is lower than its industry peers (11.7), which implies that each dollar of NEO’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 7 Tech companies in FR including Guillemot, Logic Instrument and La Société Industrielle et Financière de l’Artois. One could put it like this: the market is pricing NEO as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to NEO. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with NEO, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing NEO to are fairly valued by the market. If this does not hold true, NEO’s lower P/E ratio may be because firms in our peer group are overvalued by the market.