mDR LIMITED (SGX:A27) trades with a trailing P/E of 7.9x, which is lower than the industry average of 11.1x. While A27 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. 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 mDR

Breaking down the Price-Earnings ratio

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 A27

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

A27 Price-Earnings Ratio = SGD0 ÷ SGD0 = 7.9x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to A27, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 7.9x, A27’s P/E is lower than its industry peers (11.1x). This implies that investors are undervaluing each dollar of A27’s earnings. Therefore, according to this analysis, A27 is an under-priced stock.

A few caveats

Before you jump to the conclusion that A27 is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to A27. 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 A27, 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 A27 to are fairly valued by the market. If this does not hold true, A27’s lower P/E ratio may be because firms in our peer group are 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 undervaluation could signal a good buying opportunity to increase your exposure to A27. 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.

Are you a potential investor? If A27 has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.