Societe Francaise de Gestion et d’Investissement (ENXTPA:SOFR) is currently trading at a trailing P/E of 15.2x, which is higher than the industry average of 12.8x. 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 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 Societe Francaise de Gestion et d’Investissement
What you need to know about the P/E ratio
P/E is a popular ratio used for relative valuation. 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 SOFR
Price-Earnings Ratio = Price per share ÷ Earnings per share
SOFR Price-Earnings Ratio = €1650 ÷ €108.494 = 15.2x
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 SOFR, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. SOFR’s P/E of 15.2x is higher than its industry peers (12.8x), which implies that each dollar of SOFR’s earnings is being overvalued by investors. Therefore, according to this analysis, SOFR is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your SOFR 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 SOFR. 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 SOFR, 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 SOFR to are fairly valued by the market. If this does not hold true, SOFR’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on SOFR, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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: