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Grammer AG (DB:GMM) trades with a trailing P/E of 25.8x, which is higher than the industry average of 16.1x. While this makes GMM appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Grammer
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 GMM
Price-Earnings Ratio = Price per share ÷ Earnings per share
GMM Price-Earnings Ratio = €64 ÷ €2.483 = 25.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as GMM, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. GMM’s P/E of 25.8x is higher than its industry peers (16.1x), which implies that each dollar of GMM’s earnings is being overvalued by investors. Therefore, according to this analysis, GMM is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your GMM shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to GMM. 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 GMM, 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 GMM to are fairly valued by the market. If this is violated, GMM’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to GMM. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following: