Mayur Resources Limited (ASX:MRL) is currently trading at a trailing P/E of 11.1x, which is lower than the industry average of 14.6x. While this makes MRL appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Mayur Resources
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 MRL
Price-Earnings Ratio = Price per share ÷ Earnings per share
MRL Price-Earnings Ratio = A$0.95 ÷ A$0.086 = 11.1x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as MRL, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since MRL’s P/E of 11.1x is lower than its industry peers (14.6x), it means that investors are paying less than they should for each dollar of MRL’s earnings. Therefore, according to this analysis, MRL is an under-priced stock.
A few caveats
However, before you rush out to buy MRL, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to MRL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with MRL, 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 MRL to are fairly valued by the market. If this is violated, MRL’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? 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 MRL. 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.
Are you a potential investor? If you are considering investing in MRL, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.