Hypothekarbank Lenzburg AG (SWX:HBLN) is trading with a trailing P/E of 14.6x, which is lower than the industry average of 18.6x. 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Hypothekarbank Lenzburg
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in 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 HBLN
Price-Earnings Ratio = Price per share ÷ Earnings per share
HBLN Price-Earnings Ratio = CHF4480 ÷ CHF306.639 = 14.6x
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 HBLN, 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. Since HBLN’s P/E of 14.6x is lower than its industry peers (18.6x), it means that investors are paying less than they should for each dollar of HBLN’s earnings. As such, our analysis shows that HBLN represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy HBLN immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to HBLN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with HBLN, 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 HBLN to are fairly valued by the market. If this is violated, HBLN’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on HBLN, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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: