Regional Express Holdings Limited (ASX:REX) is currently trading at a trailing P/E of 12.4x, which is higher than the industry average of 11.1x. While this makes REX appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 Regional Express Holdings
What you need to know about the P/E ratio
P/E is a popular ratio used for relative valuation. 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 REX
Price-Earnings Ratio = Price per share ÷ Earnings per share
REX Price-Earnings Ratio = A$1.46 ÷ A$0.117 = 12.4x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to REX, 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. Since REX’s P/E of 12.4x is higher than its industry peers (11.1x), it means that investors are paying more than they should for each dollar of REX’s earnings. As such, our analysis shows that REX represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your REX shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to REX. 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 REX, 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 REX to are fairly valued by the market. If this does not hold true, REX’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 overvaluation could signal a potential selling opportunity to reduce your exposure to REX. 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.