Moreton Resources Limited (ASX:MRV) trades with a trailing P/E of 1.4x, which is lower than the industry average of 8.9x. While this makes MRV appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Moreton Resources
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 MRV
Price-Earnings Ratio = Price per share ÷ Earnings per share
MRV Price-Earnings Ratio = A$0.01 ÷ A$0.005 = 1.4x
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 MRV, 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. MRV’s P/E of 1.4x is lower than its industry peers (8.9x), which implies that each dollar of MRV’s earnings is being undervalued by investors. As such, our analysis shows that MRV represents an under-priced stock.
A few caveats
Before you jump to the conclusion that MRV is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to MRV. 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 MRV, 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 MRV to are fairly valued by the market. If this does not hold true, MRV’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.