Southern Cross Media Group Limited (ASX:SXL) trades with a trailing P/E of 8.3x, which is lower than the industry average of 16.6x. While SXL 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 Southern Cross Media Group

Breaking down the Price-Earnings ratio

P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 SXL

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

SXL Price-Earnings Ratio = A$1.06 ÷ A$0.128 = 8.3x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to SXL, 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 8.3x, SXL’s P/E is lower than its industry peers (16.6x). This implies that investors are undervaluing each dollar of SXL’s earnings. Therefore, according to this analysis, SXL is an under-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to buy SXL immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to SXL. 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 SXL, 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 SXL to are fairly valued by the market. If this does not hold, there is a possibility that SXL’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.