Gentrack Group Limited (NZSE:GTK) is currently trading at a trailing P/E of 44.3x, which is higher than the industry average of 20.7x. While GTK 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 Gentrack Group
What you need to know about 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 GTK
Price-Earnings Ratio = Price per share ÷ Earnings per share
GTK Price-Earnings Ratio = NZ$6.7 ÷ NZ$0.151 = 44.3x
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 GTK, 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 44.3x, GTK’s P/E is higher than its industry peers (20.7x). This implies that investors are overvaluing each dollar of GTK’s earnings. Therefore, according to this analysis, GTK is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that GTK 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 GTK. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with GTK, 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 GTK to are fairly valued by the market. If this does not hold, there is a possibility that GTK’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on GTK, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above.
Are you a potential investor? If you are considering investing in GTK, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.