In This Article:
Pioneer Credit Limited (ASX:PNC) is currently trading at a trailing P/E of 13.9x, which is lower than the industry average of 20.6x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. 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 Pioneer Credit
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 PNC
Price-Earnings Ratio = Price per share ÷ Earnings per share
PNC Price-Earnings Ratio = A$3.55 ÷ A$0.255 = 13.9x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to PNC, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 13.9x, PNC’s P/E is lower than its industry peers (20.6x). This implies that investors are undervaluing each dollar of PNC’s earnings. Therefore, according to this analysis, PNC is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy PNC immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to PNC, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with PNC, 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 PNC to are fairly valued by the market. If this does not hold true, PNC’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 PNC 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 highly recommend you to complete your research by taking a look at the following: