QV Equities Limited (ASX:QVE) trades with a trailing P/E of 32.5x, which is higher than the industry average of 23.4x. While QVE 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. 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 QV Equities

Breaking down the P/E ratio

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 QVE

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

QVE Price-Earnings Ratio = A$1.18 ÷ A$0.036 = 32.5x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to QVE, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. QVE’s P/E of 32.5x is higher than its industry peers (23.4x), which implies that each dollar of QVE’s earnings is being overvalued by investors. Therefore, according to this analysis, QVE is an over-priced stock.

Assumptions to watch out for

However, before you rush out to sell your QVE shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to QVE. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with QVE, 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 QVE to are fairly valued by the market. If this does not hold true, QVE’s lower P/E ratio may be because firms in our peer group are 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.