Managed Accounts Holdings Limited (ASX:MGP) trades with a trailing P/E of 51.8x, which is higher than the industry average of 18.1x. While this makes MGP 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Managed Accounts Holdings
What you need to know about the P/E ratio
P/E is a popular ratio used for 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 MGP
Price-Earnings Ratio = Price per share ÷ Earnings per share
MGP Price-Earnings Ratio = 0.26 ÷ 0.005 = 51.8x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 MGP, 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. MGP’s P/E of 51.8x is higher than its industry peers (18.1x), which implies that each dollar of MGP’s earnings is being overvalued by investors. Therefore, according to this analysis, MGP is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that MGP 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 MGP. 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 MGP, 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 MGP to are fairly valued by the market. If this does not hold, there is a possibility that MGP’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to MGP. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.