Dart Group PLC (AIM:DTG) trades with a trailing P/E of 11.2x, which is higher than the industry average of 11.2x. While this makes DTG 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. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Dart Group
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 pound of the company’s earnings.
P/E Calculation for DTG
Price-Earnings Ratio = Price per share ÷ Earnings per share
DTG Price-Earnings Ratio = 5.78 ÷ 0.518 = 11.2x
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 DTG, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use.
Assumptions to watch out for
Before you jump to the conclusion that DTG should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to DTG. 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 DTG, 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 DTG to are fairly valued by the market. If this does not hold true, DTG’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? 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 DTG. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in DTG, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.