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Kemira Oyj (HLSE:KEMIRA) is trading with a trailing P/E of 21.1x, which is higher than the industry average of 20x. While KEMIRA might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Kemira Oyj
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 KEMIRA
Price-Earnings Ratio = Price per share ÷ Earnings per share
KEMIRA Price-Earnings Ratio = €10.89 ÷ €0.516 = 21.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as KEMIRA, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 21.1x, KEMIRA’s P/E is higher than its industry peers (20x). This implies that investors are overvaluing each dollar of KEMIRA’s earnings. As such, our analysis shows that KEMIRA represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that KEMIRA should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to KEMIRA. 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 KEMIRA, 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 KEMIRA to are fairly valued by the market. If this is violated, KEMIRA’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in KEMIRA. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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: