This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Hornbach Holding AG & Co KGaA (FRA:HBH) is trading with a trailing P/E of 11.9x, which is lower than the industry average of 16.2x. While this makes HBH appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
Check out our latest analysis for Hornbach Holding KGaA
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 HBH
Price-Earnings Ratio = Price per share ÷ Earnings per share
HBH Price-Earnings Ratio = €55.1 ÷ €4.62 = 11.9x
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 HBH, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since HBH’s P/E of 11.9 is lower than its industry peers (16.2), it means that investors are paying less for each dollar of HBH’s earnings. This multiple is a median of profitable companies of 25 Specialty Retail companies in DE including Folli-Follie Commercial Manufacturing and Technical Societe Anonyme, J.Jill and Beijing Digital Telecom. You can think of it like this: the market is suggesting that HBH is a weaker business than the average comparable company.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to HBH, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with HBH, 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 HBH to are fairly valued by the market. If this does not hold true, HBH’s lower P/E ratio may be because firms in our peer group are overvalued by the market.