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EVN AG (WBAG:EVN) is currently trading at a trailing P/E of 11.2x, which is lower than the industry average of 13.7x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for EVN
Demystifying the P/E ratio
P/E is a popular ratio used for 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 EVN
Price-Earnings Ratio = Price per share ÷ Earnings per share
EVN Price-Earnings Ratio = €16.9 ÷ €1.506 = 11.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to EVN, 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. EVN’s P/E of 11.2x is lower than its industry peers (13.7x), which implies that each dollar of EVN’s earnings is being undervalued by investors. Therefore, according to this analysis, EVN is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy EVN immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to EVN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with EVN, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing EVN to are fairly valued by the market. If this does not hold, there is a possibility that EVN’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to EVN. 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: