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 start learning about core concepts of fundamental analysis on practical examples from today’s market.
Ypsomed Holding AG (VTX:YPSN) trades with a trailing P/E of 34, which is higher than the industry average of 30.4. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Ypsomed Holding
What you need to know about 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 YPSN
Price-Earnings Ratio = Price per share ÷ Earnings per share
YPSN Price-Earnings Ratio = CHF140.8 ÷ CHF4.136 = 34x
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 YPSN, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. YPSN’s P/E of 34 is higher than its industry peers (30.4), which implies that each dollar of YPSN’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 4 Medical Equipment companies in CH including COLTENE Holding, IVF Hartmann Holding and Sonova Holding. You could also say that the market is suggesting that YPSN is a stronger business than the average comparable company.
A few caveats
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to YPSN. If this isn’t the case, the difference in P/E could be due to other factors. For example, Ypsomed Holding AG could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with YPSN are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
Since you may have already conducted your due diligence on YPSN, the overvaluation of the stock may mean it is a good time to reduce 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: