PGS Software SA. (WSE:PSW) is currently trading at a trailing P/E of 53.1x, which is higher than the industry average of 24.7x. While PSW 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. View our latest analysis for PGS Software
Demystifying 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 PSW
Price-Earnings Ratio = Price per share ÷ Earnings per share
PSW Price-Earnings Ratio = PLN10.7 ÷ PLN0.201 = 53.1x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to PSW, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 53.1x, PSW’s P/E is higher than its industry peers (24.7x). This implies that investors are overvaluing each dollar of PSW’s earnings. Therefore, according to this analysis, PSW is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your PSW 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 PSW. 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 PSW, 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 PSW to are fairly valued by the market. If this does not hold true, PSW’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in PSW. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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: