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BSA Limited (ASX:BSA) is currently trading at a trailing P/E of 28.6x, which is higher than the industry average of 16.4x. While BSA 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for BSA
What you need to know about the P/E 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 BSA
Price-Earnings Ratio = Price per share ÷ Earnings per share
BSA Price-Earnings Ratio = A$0.34 ÷ A$0.012 = 28.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as BSA, 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. BSA’s P/E of 28.6x is higher than its industry peers (16.4x), which implies that each dollar of BSA’s earnings is being overvalued by investors. Therefore, according to this analysis, BSA is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your BSA shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to BSA. 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 BSA, 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 BSA to are fairly valued by the market. If this is violated, BSA’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.