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Mayr-Melnhof Karton AG (WBAG:MMK) is currently trading at a trailing P/E of 16.6x, 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 explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Mayr-Melnhof Karton
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 MMK
Price-Earnings Ratio = Price per share ÷ Earnings per share
MMK Price-Earnings Ratio = €128 ÷ €7.729 = 16.6x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to MMK, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 16.6x, MMK’s P/E is lower than its industry peers (18.6x). This implies that investors are undervaluing each dollar of MMK’s earnings. Therefore, according to this analysis, MMK is an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that MMK 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 MMK, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with MMK, 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 MMK to are fairly valued by the market. If this is violated, MMK’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 MMK, 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: