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Insplanet AB (publ) (OM:IPL) is trading with a trailing P/E of 59x, which is higher than the industry average of 15.3x. While IPL 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. In this article, 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 Insplanet
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 IPL
Price-Earnings Ratio = Price per share ÷ Earnings per share
IPL Price-Earnings Ratio = SEK10.8 ÷ SEK0.183 = 59x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 IPL, 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. Since IPL’s P/E of 59x is higher than its industry peers (15.3x), it means that investors are paying more than they should for each dollar of IPL’s earnings. As such, our analysis shows that IPL represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your IPL shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to IPL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with IPL, 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 IPL to are fairly valued by the market. If this does not hold true, IPL’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.