Exmar NV (ENXTBR:EXM) is trading with a trailing P/E of 8x, which is lower than the industry average of 14.2x. While this makes EXM 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Exmar
Demystifying the P/E 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 EXM
Price-Earnings Ratio = Price per share ÷ Earnings per share
EXM Price-Earnings Ratio = $7.57 ÷ $0.941 = 8x
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 EXM, 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 EXM’s P/E of 8x is lower than its industry peers (14.2x), it means that investors are paying less than they should for each dollar of EXM’s earnings. Therefore, according to this analysis, EXM is an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that EXM 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 EXM, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with EXM, 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 EXM to are fairly valued by the market. If this does not hold true, EXM’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to EXM. 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. 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:
- Future Outlook: What are well-informed industry analysts predicting for EXM’s future growth? Take a look at our free research report of analyst consensus for EXM’s outlook.
- Past Track Record: Has EXM been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of EXM’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.