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Grange Resources Limited (ASX:GRR) is currently trading at a trailing P/E of 3.5x, which is lower than the industry average of 13.6x. While GRR 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. View our latest analysis for Grange Resources
Breaking down the P/E ratio
P/E is a popular ratio used for relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for GRR
Price-Earnings Ratio = Price per share ÷ Earnings per share
GRR Price-Earnings Ratio = A$0.19 ÷ A$0.052 = 3.5x
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 GRR, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. GRR’s P/E of 3.5x is lower than its industry peers (13.6x), which implies that each dollar of GRR’s earnings is being undervalued by investors. As such, our analysis shows that GRR represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that GRR 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 GRR, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with GRR, 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 GRR to are fairly valued by the market. If this is violated, GRR’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 undervaluation could signal a good buying opportunity to increase your exposure to GRR. 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: