The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Intertrust NV (AMS:INTER) is trading with a trailing P/E of 16.5x, which is lower than the industry average of 19.9x. While INTER 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for Intertrust
What you need to know about 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 INTER
Price-Earnings Ratio = Price per share ÷ Earnings per share
INTER Price-Earnings Ratio = €16.35 ÷ €0.992 = 16.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as INTER, 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. INTER’s P/E of 16.5 is lower than its industry peers (19.9), which implies that each dollar of INTER’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 7 Professional Services companies in NL including Randstad, RELX and Wolters Kluwer. You can think of it like this: the market is suggesting that INTER is a weaker business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to INTER. 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 INTER, 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 INTER to are fairly valued by the market. If this is violated, INTER’s P/E may be lower than its peers as they are actually overvalued by investors.