John Laing Group plc (LSE:JLG) trades with a trailing P/E of 8.6x, which is lower than the industry average of 14.3x. While this makes JLG appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for John Laing Group
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 pound of the company’s earnings.
P/E Calculation for JLG
Price-Earnings Ratio = Price per share ÷ Earnings per share
JLG Price-Earnings Ratio = 2.83 ÷ 0.33 = 8.6x
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 JLG, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since JLG's P/E of 8.6x is lower than its industry peers (14.3x), it means that investors are paying less than they should for each dollar of JLG's earnings. Therefore, according to this analysis, JLG is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy JLG, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to JLG. 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 JLG, 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 JLG to are fairly valued by the market. If this is violated, JLG's P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on JLG, the undervaluation of the stock may mean it is a good time to top up on 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 JLG, 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.