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Lipetsk Power Sale Company Open Joint-Stock Company (MISX:LPSB) trades with a trailing P/E of 4.3x, which is lower than the industry average of 6.3x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Lipetsk Power Sale Company
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 LPSB
Price-Earnings Ratio = Price per share ÷ Earnings per share
LPSB Price-Earnings Ratio = RUB3.32 ÷ RUB0.775 = 4.3x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as LPSB, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since LPSB’s P/E of 4.3x is lower than its industry peers (6.3x), it means that investors are paying less than they should for each dollar of LPSB’s earnings. Therefore, according to this analysis, LPSB is an under-priced stock.
A few caveats
However, before you rush out to buy LPSB, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to LPSB, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with LPSB, 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 LPSB to are fairly valued by the market. If this is violated, LPSB’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on LPSB, the undervaluation of the stock may mean it is a good time to top up on 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: