Yahoo Finance Does Mount Gibson Iron Limited’s (ASX:MGX) PE Ratio Warrant A Buy?
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Mount Gibson Iron Limited (ASX:MGX) is trading with a trailing P/E of 5.4x, which is lower than the industry average of 11x. While MGX 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for Mount Gibson Iron
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 MGX
Price-Earnings Ratio = Price per share ÷ Earnings per share
MGX Price-Earnings Ratio = A$0.49 ÷ A$0.0908 = 5.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 MGX, 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. At 5.4, MGX’s P/E is lower than its industry peers (11). This implies that investors are undervaluing each dollar of MGX’s earnings. This multiple is a median of profitable companies of 24 Metals and Mining companies in AU including Gladiator Resources, Aeris Resources and Rox Resources. One could put it like this: the market is pricing MGX as if it is a weaker company than the average company in its industry.
A few caveats
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to MGX, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with MGX, 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 MGX to are fairly valued by the market. If this does not hold true, MGX’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on MGX, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for MGX’s future growth? Take a look at our free research report of analyst consensus for MGX’s outlook.
Past Track Record: Has MGX 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 MGX’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 editorial-team@simplywallst.com.
