Pantoro Limited (ASX:PNR) is currently trading at a trailing P/E of 18.8x, which is higher than the industry average of 13.5x. While this makes PNR appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Pantoro

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 PNR

Price-Earnings Ratio = Price per share ÷ Earnings per share

PNR Price-Earnings Ratio = A$0.3 ÷ A$0.016 = 18.8x

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. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as PNR, 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. Since PNR’s P/E of 18.8x is higher than its industry peers (13.5x), it means that investors are paying more than they should for each dollar of PNR’s earnings. Therefore, according to this analysis, PNR is an over-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to sell your PNR shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to PNR, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with PNR, 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 PNR to are fairly valued by the market. If this is violated, PNR’s P/E may be lower than its peers as they are actually overvalued by investors.

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.