Skjern Bank A/S (CPSE:SKJE) trades with a trailing P/E of 5.2x, which is lower than the industry average of 8.8x. While SKJE 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Skjern Bank

Demystifying the P/E ratio

P/E is a popular ratio used for 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 dollar of the company’s earnings.

P/E Calculation for SKJE

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

SKJE Price-Earnings Ratio = DKK64.2 ÷ DKK12.3 = 5.2x

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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SKJE, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 5.2x, SKJE’s P/E is lower than its industry peers (8.8x). This implies that investors are undervaluing each dollar of SKJE’s earnings. Therefore, according to this analysis, SKJE is an under-priced stock.

A few caveats

Before you jump to the conclusion that SKJE 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 SKJE, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with SKJE, 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 SKJE to are fairly valued by the market. If this does not hold, there is a possibility that SKJE’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.