Umanis SA (ENXTPA:ALUMS) trades with a trailing P/E of 14.5x, which is lower than the industry average of 21.4x. While this makes ALUMS appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Umanis
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 ALUMS
Price-Earnings Ratio = Price per share ÷ Earnings per share
ALUMS Price-Earnings Ratio = €15.95 ÷ €1.096 = 14.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ALUMS, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. ALUMS’s P/E of 14.5x is lower than its industry peers (21.4x), which implies that each dollar of ALUMS’s earnings is being undervalued by investors. As such, our analysis shows that ALUMS represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that ALUMS is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to ALUMS, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with ALUMS, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing ALUMS to are fairly valued by the market. If this is violated, ALUMS’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 add more of ALUMS to your portfolio. 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: