MS INTERNATIONAL plc (AIM:MSI) is currently trading at a trailing P/E of 14.6x, which is lower than the industry average of 14.9x. While MSI 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for MS INTERNATIONAL
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 pound of the company’s earnings.
P/E Calculation for MSI
Price-Earnings Ratio = Price per share ÷ Earnings per share
MSI Price-Earnings Ratio = £1.99 ÷ £0.136 = 14.6x
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. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as MSI, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. MSI’s P/E of 14.6x is lower than its industry peers (14.9x), which implies that each dollar of MSI’s earnings is being undervalued by investors. Therefore, according to this analysis, MSI is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy MSI, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to MSI, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with MSI, 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 MSI to are fairly valued by the market. If this is violated, MSI’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 MSI. 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 MSI, 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.