In This Article:
Banca Profilo Sp.A. (BIT:PRO) is trading with a trailing P/E of 28.4x, which is higher than the industry average of 15.9x. While this makes PRO 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Banca Profilo
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 PRO
Price-Earnings Ratio = Price per share ÷ Earnings per share
PRO Price-Earnings Ratio = €0.23 ÷ €0.008 = 28.4x
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 PRO, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 28.4x, PRO’s P/E is higher than its industry peers (15.9x). This implies that investors are overvaluing each dollar of PRO’s earnings. Therefore, according to this analysis, PRO is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your PRO shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to PRO. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with PRO, 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 PRO to are fairly valued by the market. If this does not hold true, PRO’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in PRO. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following: