In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Evonik Industries AG (FRA:EVK) is currently trading at a trailing P/E of 15.6x, which is lower than the industry average of 16.8x. While EVK 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. 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 Evonik Industries
Demystifying 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 EVK
Price-Earnings Ratio = Price per share ÷ Earnings per share
EVK Price-Earnings Ratio = €31.53 ÷ €2.023 = 15.6x
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 EVK, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since EVK’s P/E of 15.6x is lower than its industry peers (16.8x), it means that investors are paying less than they should for each dollar of EVK’s earnings. This multiple is a median of profitable companies of 25 Chemicals companies in DE including Decheng Technology, Decheng Technology and China Green Agriculture. As such, our analysis shows that EVK represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that EVK is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to EVK, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with EVK, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing EVK to are fairly valued by the market. If this does not hold true, EVK’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to EVK. 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 highly recommend you to complete your research by taking a look at the following: