Yahoo Finance Is Seven Generations Energy Ltd (TSX:VII) A Buy At Its Current Price?
Seven Generations Energy Ltd (TSX:VII) is trading with a trailing P/E of 21.8x, which is lower than the industry average of 27.6x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Seven Generations Energy
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.
Formula
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for VII
Price per share = 18.35
Earnings per share = 0.84
∴ Price-Earnings Ratio = 18.35 ÷ 0.84 = 21.8x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to VII, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
At 21.8x, VII’s P/E is lower than its industry peers (27.6x). This implies that investors are undervaluing each dollar of VII’s earnings. As such, our analysis shows that VII represents an under-priced stock.
A few caveats
Before you jump to the conclusion that VII represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to VII. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with VII, then investors would naturally value VII at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with VII, investors would also value VII at a lower price since it is a lower growth investment. Both scenarios would explain why VII has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing VII to are fairly valued by the market. If this assumption is violated, VII's P/E may be lower than its peers because its peers are actually overvalued by investors.
What this means for you:
Are you a shareholder? 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 VII 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.
Are you a potential investor? If VII has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Seven Generations Energy for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
