Yahoo Finance Is South32 Limited’s (ASX:S32) PE Ratio A Signal To Buy For Investors?
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.
South32 Limited (ASX:S32) trades with a trailing P/E of 9.9x, which is lower than the industry average of 12x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
See our latest analysis for South32
What you need to know about 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 S32
Price-Earnings Ratio = Price per share ÷ Earnings per share
S32 Price-Earnings Ratio = $2.56 ÷ $0.258 = 9.9x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as S32, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. S32’s P/E of 9.9 is lower than its industry peers (12), which implies that each dollar of S32’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 25 Metals and Mining companies in AU including Gladiator Resources, Titan Minerals and Citigold. One could put it like this: the market is pricing S32 as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to S32. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with S32, 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 S32 to are fairly valued by the market. If this does not hold, there is a possibility that S32’s P/E is lower because our peer group is 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 S32. 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 S32’s future growth? Take a look at our free research report of analyst consensus for S32’s outlook.
Past Track Record: Has S32 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 S32’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.
