Quabit Inmobiliaria SA. (BME:QBT) trades with a trailing P/E of 10.2x, which is lower than the industry average of 39.5x. 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. In this article, 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 Quabit Inmobiliaria

Breaking down the Price-Earnings ratio

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 QBT

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

QBT Price-Earnings Ratio = €2.07 ÷ €0.204 = 10.2x

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 QBT, 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. At 10.2x, QBT’s P/E is lower than its industry peers (39.5x). This implies that investors are undervaluing each dollar of QBT’s earnings. As such, our analysis shows that QBT represents an under-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to buy QBT immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to QBT, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with QBT, 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 QBT to are fairly valued by the market. If this is violated, QBT’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.