Yahoo Finance Does Thomson Resources Ltd’s (ASX:TMZ) PE Ratio Signal A Buying Opportunity?
I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Thomson Resources Ltd (ASX:TMZ) is currently trading at a trailing P/E of 5.6x, which is lower than the industry average of 11x. While this makes TMZ 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 Thomson Resources
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for TMZ
Price-Earnings Ratio = Price per share ÷ Earnings per share
TMZ Price-Earnings Ratio = A$0.036 ÷ A$0.00645 = 5.6x
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 TMZ, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since TMZ’s P/E of 5.6 is lower than its industry peers (11), it means that investors are paying less for each dollar of TMZ’s earnings. This multiple is a median of profitable companies of 24 Metals and Mining companies in AU including Aeris Resources, Citigold and Highlands Pacific. One could put it like this: the market is pricing TMZ as if it is a weaker company than the average company in its industry.
A few caveats
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to TMZ. 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 TMZ, 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 TMZ to are fairly valued by the market. If this is violated, TMZ’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on TMZ, 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:
Financial Health: Are TMZ’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
Past Track Record: Has TMZ 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 TMZ’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.
