Tegel Group Holdings Limited (NZSE:TGH) is currently trading at a trailing P/E of 9.3x, which is lower than the industry average of 18.9x. While this makes TGH appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Tegel Group Holdings

Breaking down the Price-Earnings 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 dollar of the company’s earnings.

P/E Calculation for TGH

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

TGH Price-Earnings Ratio = NZ$0.9 ÷ NZ$0.097 = 9.3x

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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to TGH, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 9.3x, TGH’s P/E is lower than its industry peers (18.9x). This implies that investors are undervaluing each dollar of TGH’s earnings. Therefore, according to this analysis, TGH is an under-priced stock.

A few caveats

Before you jump to the conclusion that TGH is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to TGH, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with TGH, 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 TGH to are fairly valued by the market. If this does not hold, there is a possibility that TGH’s P/E is lower because our peer group is 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.