Elite Varainhoito Oyj (HLSE:ELVHB) is trading with a trailing P/E of 28.1x, which is higher than the industry average of 14.6x. While this makes ELVHB appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Elite Varainhoito Oyj

What you need to know about 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 ELVHB

Price-Earnings Ratio = Price per share ÷ Earnings per share

ELVHB Price-Earnings Ratio = €3.2 ÷ €0.114 = 28.1x

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 ELVHB, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. ELVHB’s P/E of 28.1x is higher than its industry peers (14.6x), which implies that each dollar of ELVHB’s earnings is being overvalued by investors. As such, our analysis shows that ELVHB represents an over-priced stock.

A few caveats

While our conclusion might prompt you to sell your ELVHB shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to ELVHB. 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 ELVHB, 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 ELVHB to are fairly valued by the market. If this is violated, ELVHB’s P/E may be lower than its peers as they are actually overvalued by investors.

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.