SEEK Limited (ASX:SEK) trades with a trailing P/E of 19x, which is lower than the industry average of 22x. While SEK 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for SEK
What you need to know about the P/E 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 SEK
Price-Earnings Ratio = Price per share ÷ Earnings per share
SEK Price-Earnings Ratio = A$18.63 ÷ A$0.979 = 19x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SEK, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 19x, SEK’s P/E is lower than its industry peers (22x). This implies that investors are undervaluing each dollar of SEK’s earnings. As such, our analysis shows that SEK represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that SEK 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 SEK. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with SEK, 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 SEK to are fairly valued by the market. If this does not hold, there is a possibility that SEK’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 undervaluation could signal a good buying opportunity to increase your exposure to SEK. 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 you are considering investing in SEK, 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.