This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Intermin Resources Ltd (ASX:IRC) is currently trading at a trailing P/E of 13.2, which is higher than the industry average of 11.3. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 Intermin Resources
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in 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 IRC
Price-Earnings Ratio = Price per share ÷ Earnings per share
IRC Price-Earnings Ratio = A$0.17 ÷ A$0.0129 = 13.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to IRC, 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. At 13.2, IRC’s P/E is higher than its industry peers (11.3). This implies that investors are overvaluing each dollar of IRC’s earnings. This multiple is a median of profitable companies of 25 Metals and Mining companies in AU including Gladiator Resources, Aeris Resources and Citigold. You could think of it like this: the market is pricing IRC as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to IRC. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Intermin Resources Ltd is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to IRC may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
Since you may have already conducted your due diligence on IRC, the overvaluation of the stock may mean it is a good time to reduce 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 urge you to complete your research by taking a look at the following: