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Itera ASA (OB:ITE) is trading with a trailing P/E of 24.9x, which is higher than the industry average of 21.7x. While ITE might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 Itera
What you need to know about 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 ITE
Price-Earnings Ratio = Price per share ÷ Earnings per share
ITE Price-Earnings Ratio = NOK8.96 ÷ NOK0.36 = 24.9x
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 ITE, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. ITE’s P/E of 24.9x is higher than its industry peers (21.7x), which implies that each dollar of ITE’s earnings is being overvalued by investors. As such, our analysis shows that ITE represents an over-priced stock.
A few caveats
However, before you rush out to sell your ITE shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to ITE. 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 ITE, 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 ITE to are fairly valued by the market. If this is violated, ITE’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in ITE. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 urge you to complete your research by taking a look at the following: