TPG Telecom Limited (ASX:TPM) is currently trading at a trailing P/E of 12.6x, which is lower than the industry average of 20.8x. While TPM 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. Check out our latest analysis for TPG Telecom
What you need to know about 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 TPM
Price-Earnings Ratio = Price per share ÷ Earnings per share
TPM Price-Earnings Ratio = A$5.42 ÷ A$0.43 = 12.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to TPM, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. TPM’s P/E of 12.6x is lower than its industry peers (20.8x), which implies that each dollar of TPM’s earnings is being undervalued by investors. As such, our analysis shows that TPM represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy TPM immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to TPM, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with TPM, 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 TPM to are fairly valued by the market. If this does not hold true, TPM’s lower P/E ratio may be because firms in our peer group are 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.