Sol SpA (BIT:SOL) trades with a trailing P/E of 24.9x, which is higher than the industry average of 23.3x. While this makes SOL appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Sol
Demystifying the P/E ratio
P/E is a popular ratio used for 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 SOL
Price-Earnings Ratio = Price per share ÷ Earnings per share
SOL Price-Earnings Ratio = €11.44 ÷ €0.459 = 24.9x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to SOL, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 24.9x, SOL’s P/E is higher than its industry peers (23.3x). This implies that investors are overvaluing each dollar of SOL’s earnings. Therefore, according to this analysis, SOL is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your SOL shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to SOL, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with SOL, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing SOL to are fairly valued by the market. If this does not hold true, SOL’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 rebalance your portfolio and reduce your holdings in SOL. 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: