I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Aberdeen International Inc (TSE:AAB) is currently trading at a trailing P/E of 1x, which is lower than the industry average of 10.8x. While AAB might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Breaking down 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 AAB
Price-Earnings Ratio = Price per share ÷ Earnings per share
AAB Price-Earnings Ratio = CA$0.090 ÷ CA$0.0942 = 1x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as AAB, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since AAB’s P/E of 1 is lower than its industry peers (10.8), it means that investors are paying less for each dollar of AAB’s earnings. This multiple is a median of profitable companies of 21 Capital Markets companies in CA including Quinsam Capital, ThreeD Capital and Consolidated Firstfund Capital. One could put it like this: the market is pricing AAB as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to AAB. 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 AAB, 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 AAB to are fairly valued by the market. If this is violated, AAB’s P/E may be lower than its peers as they are actually overvalued by investors.
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 AAB. 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 AAB’s future growth? Take a look at our free research report of analyst consensus for AAB’s outlook.
- Past Track Record: Has AAB 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 AAB’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 past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.