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Bouygues SA (ENXTPA:EN) is currently trading at a trailing P/E of 13.9x, which is lower than the industry average of 16.7x. While EN might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Bouygues
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 EN
Price-Earnings Ratio = Price per share ÷ Earnings per share
EN Price-Earnings Ratio = €42.17 ÷ €3.031 = 13.9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to EN, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 13.9x, EN’s P/E is lower than its industry peers (16.7x). This implies that investors are undervaluing each dollar of EN’s earnings. Therefore, according to this analysis, EN is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy EN immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to EN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with EN, 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 EN to are fairly valued by the market. If this does not hold true, EN’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 add more of EN to your portfolio. 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: