GL Limited (SGX:B16) is currently trading at a trailing P/E of 9.8x, which is lower than the industry average of 24.2x. While B16 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for GL
What you need to know about 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. 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 B16
Price-Earnings Ratio = Price per share ÷ Earnings per share
B16 Price-Earnings Ratio = $0.6 ÷ $0.061 = 9.8x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as B16, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. B16’s P/E of 9.8x is lower than its industry peers (24.2x), which implies that each dollar of B16’s earnings is being undervalued by investors. As such, our analysis shows that B16 represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy B16 immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to B16, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with B16, 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 B16 to are fairly valued by the market. If this is violated, B16’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on B16, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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: