Mineral Resources Limited (ASX:MIN) is currently trading at a trailing P/E of 14.5x, which is higher than the industry average of 13.1x. While MIN 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Mineral Resources

Demystifying 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. 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 MIN

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

MIN Price-Earnings Ratio = A$17.38 ÷ A$1.2 = 14.5x

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 MIN, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. MIN’s P/E of 14.5x is higher than its industry peers (13.1x), which implies that each dollar of MIN’s earnings is being overvalued by investors. Therefore, according to this analysis, MIN is an over-priced stock.

A few caveats

Before you jump to the conclusion that MIN should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to MIN. 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 MIN, 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 MIN to are fairly valued by the market. If this does not hold, there is a possibility that MIN’s P/E is lower because our peer group is 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.