Is Persimmon Plc’s (LON:PSN) PE Ratio A Signal To Sell For Investors?

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The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.

Persimmon Plc (LON:PSN) is trading with a trailing P/E of 9.7x, which is higher than the industry average of 9.4x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, 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.

Check out our latest analysis for Persimmon

Breaking down the Price-Earnings ratio

LSE:PSN PE PEG Gauge August 18th 18
LSE:PSN PE PEG Gauge August 18th 18

P/E is a popular ratio used for relative valuation. 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 PSN

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

PSN Price-Earnings Ratio = £24.62 ÷ £2.55 = 9.7x

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 PSN, 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 PSN’s P/E of 9.7x is higher than its industry peers (9.4x), it means that investors are paying more than they should for each dollar of PSN’s earnings. This multiple is a median of profitable companies of 24 Consumer Durables companies in GB including Springfield Properties, Walker Greenbank and Crest Nicholson Holdings. Therefore, according to this analysis, PSN is an over-priced stock.

Assumptions to watch out for

Before you jump to the conclusion that PSN should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to PSN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with PSN, 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 PSN to are fairly valued by the market. If this does not hold true, PSN’s lower P/E ratio may be because firms in our peer group are overvalued by the market.