This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Valsoia SpA (BIT:VLS) is trading with a trailing P/E of 23.8x, which is higher than the industry average of 19.9x. While this makes VLS 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 Valsoia
Breaking down the Price-Earnings 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 VLS
Price-Earnings Ratio = Price per share ÷ Earnings per share
VLS Price-Earnings Ratio = €15.65 ÷ €0.659 = 23.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 VLS, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. VLS’s P/E of 23.8x is higher than its industry peers (19.9x), which implies that each dollar of VLS’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 5 Food companies in IT including La Doria, Massimo Zanetti Beverage Group and Danone. As such, our analysis shows that VLS represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your VLS shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to VLS, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with VLS, 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 VLS to are fairly valued by the market. If this is violated, VLS’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to VLS. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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: