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.
Ifirma SA (WSE:IFI) is trading with a trailing P/E of 13.2x, which is lower than the industry average of 31.8x. While IFI might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, 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 Ifirma
Breaking down 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 IFI
Price-Earnings Ratio = Price per share ÷ Earnings per share
IFI Price-Earnings Ratio = PLN3.1 ÷ PLN0.234 = 13.2x
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 IFI, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. IFI’s P/E of 13.2x is lower than its industry peers (31.8x), which implies that each dollar of IFI’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 12 Internet companies in PL including Cloud Technologies, eo Networks and K2 Internet. As such, our analysis shows that IFI represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy IFI immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to IFI. 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 IFI, 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 IFI to are fairly valued by the market. If this does not hold true, IFI’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on IFI, 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: