This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Reno De Medici SpA (BIT:RM) is currently trading at a trailing P/E of 14.6x, which is lower than the industry average of 15.8x. 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for Reno De Medici
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 RM
Price-Earnings Ratio = Price per share ÷ Earnings per share
RM Price-Earnings Ratio = €1.01 ÷ €0.0692 = 14.6x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to RM, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 14.6x, RM’s P/E is lower than its industry peers (16x). This implies that investors are undervaluing each dollar of RM’s earnings. Since the Packaging sector in IT is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as Zignago Vetro, and . As such, our analysis shows that RM represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy RM immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to RM. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with RM, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing RM to are fairly valued by the market. If this does not hold true, RM’s lower P/E ratio may be because firms in our peer group are overvalued by the market.