The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Axiom Properties Limited (ASX:AXI) is currently trading at a trailing P/E of 2.2x, which is lower than the industry average of 11.6x. 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 Axiom Properties
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 AXI
Price-Earnings Ratio = Price per share ÷ Earnings per share
AXI Price-Earnings Ratio = A$0.043 ÷ A$0.0198 = 2.2x
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 AXI, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since AXI’s P/E of 2.2 is lower than its industry peers (11.6), it means that investors are paying less for each dollar of AXI’s earnings. This multiple is a median of profitable companies of 23 Real Estate companies in AU including Aveo Group, Phileo Australia and International Equities. You can think of it like this: the market is suggesting that AXI is a weaker business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. The first is that our “similar companies” are actually similar to AXI, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with AXI, 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 AXI to are fairly valued by the market. If this does not hold true, AXI’s lower P/E ratio may be because firms in our peer group are overvalued by the market.