FSA Group Limited (ASX:FSA) trades with a trailing P/E of 12.2x, which is lower than the industry average of 17.2x. While FSA might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 FSA Group

What you need to know about the P/E ratio

A common ratio used for relative valuation is the P/E ratio. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.

P/E Calculation for FSA

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

FSA Price-Earnings Ratio = A$1.48 ÷ A$0.121 = 12.2x

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 FSA, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 12.2x, FSA’s P/E is lower than its industry peers (17.2x). This implies that investors are undervaluing each dollar of FSA’s earnings. As such, our analysis shows that FSA represents an under-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to buy FSA immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to FSA. 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 FSA, 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 FSA to are fairly valued by the market. If this is violated, FSA’s P/E may be lower than its peers as they are actually overvalued by investors.

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.