Koninklijke Wessanen NV. (ENXTAM:WES) is trading with a trailing P/E of 33.7x, which is higher than the industry average of 18.4x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Koninklijke Wessanen

What you need to know about the P/E ratio

A common ratio used for relative valuation is the P/E ratio. 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 WES

Price-Earnings Ratio = Price per share ÷ Earnings per share

WES Price-Earnings Ratio = €16.03 ÷ €0.475 = 33.7x

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 WES, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. WES’s P/E of 33.7x is higher than its industry peers (18.4x), which implies that each dollar of WES’s earnings is being overvalued by investors. As such, our analysis shows that WES represents an over-priced stock.

A few caveats

However, before you rush out to sell your WES shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to WES, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with WES, 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 WES to are fairly valued by the market. If this does not hold, there is a possibility that WES’s P/E is lower because our peer group is 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.