Pinnacle Investment Management Group Limited (ASX:PNI) is trading with a trailing P/E of 38.4x, which is higher than the industry average of 21.6x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, 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 Pinnacle Investment Management Group
Breaking down the P/E ratio
P/E is a popular ratio used for 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 PNI
Price-Earnings Ratio = Price per share ÷ Earnings per share
PNI Price-Earnings Ratio = 3.13 ÷ 0.081 = 38.4x
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 PNI, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. PNI’s P/E of 38.4x is higher than its industry peers (21.6x), which implies that each dollar of PNI’s earnings is being overvalued by investors. Therefore, according to this analysis, PNI is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your PNI shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to PNI, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with PNI, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing PNI to are fairly valued by the market. If this does not hold, there is a possibility that PNI’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to PNI. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If you are considering investing in PNI, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.