Blue Sky Alternative Investments Limited (ASX:BLA) is currently trading at a trailing P/E of 43x, which is higher than the industry average of 21.5x. While BLA might seem like a stock to avoid or sell if you own it, 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. Check out our latest analysis for Blue Sky Alternative Investments
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 BLA
Price-Earnings Ratio = Price per share ÷ Earnings per share
BLA Price-Earnings Ratio = A$13.16 ÷ A$0.306 = 43x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 BLA, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 43x, BLA’s P/E is higher than its industry peers (21.5x). This implies that investors are overvaluing each dollar of BLA’s earnings. Therefore, according to this analysis, BLA is an over-priced stock.
A few caveats
Before you jump to the conclusion that BLA should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to BLA, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with BLA, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing BLA to are fairly valued by the market. If this is violated, BLA’s P/E may be lower than its peers as they are actually overvalued by investors.
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.