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Telenor ASA (OB:TEL) is currently trading at a trailing P/E of 21.8x, which is higher than the industry average of 17.3x. 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. Today, 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 Telenor
Breaking down the Price-Earnings 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 TEL
Price-Earnings Ratio = Price per share ÷ Earnings per share
TEL Price-Earnings Ratio = NOK177 ÷ NOK8.128 = 21.8x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to TEL, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 21.8x, TEL’s P/E is higher than its industry peers (17.3x). This implies that investors are overvaluing each dollar of TEL’s earnings. Therefore, according to this analysis, TEL is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your TEL 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 TEL. 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 TEL, 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 TEL to are fairly valued by the market. If this does not hold true, TEL’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.