In This Article:
I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
TGS-NOPEC Geophysical Company ASA (OB:TGS) trades with a trailing P/E of 38.9, which is higher than the industry average of 21.9. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Check out our latest analysis for TGS-NOPEC Geophysical
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 TGS
Price-Earnings Ratio = Price per share ÷ Earnings per share
TGS Price-Earnings Ratio = $34.58 ÷ $0.888 = 38.9x
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 TGS, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. TGS’s P/E of 38.9 is higher than its industry peers (21.9), which implies that each dollar of TGS’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 8 Energy Services companies in NO including Kværner, Ocean Yield and Subsea 7. You could think of it like this: the market is pricing TGS as if it is a stronger company than the average of its industry group.
A few caveats
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to TGS. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where TGS-NOPEC Geophysical Company ASA is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with TGS are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to TGS. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 urge you to complete your research by taking a look at the following: