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Should You Be Tempted To Sell IPH Limited (ASX:IPH) At Its Current PE Ratio?

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.

IPH Limited (ASX:IPH) trades with a trailing P/E of 27, which is higher than the industry average of 23. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.

See our latest analysis for IPH

Breaking down the P/E ratio

ASX:IPH PE PEG Gauge September 22nd 18
ASX:IPH PE PEG Gauge September 22nd 18

P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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.

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P/E Calculation for IPH

Price-Earnings Ratio = Price per share ÷ Earnings per share

IPH Price-Earnings Ratio = A$5.61 ÷ A$0.208 = 27x

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 IPH, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. IPH’s P/E of 27 is higher than its industry peers (23), which implies that each dollar of IPH’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 11 Professional Services companies in AU including Energy Action, Ashley Services Group and HiTech Group Australia. You could think of it like this: the market is pricing IPH as if it is a stronger company than the average of its industry group.

Assumptions to be aware of

Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to IPH. If this isn’t the case, the difference in P/E could be due to other factors. For example, IPH Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to IPH may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to IPH. 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 urge you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for IPH’s future growth? Take a look at our free research report of analyst consensus for IPH’s outlook.

  2. Past Track Record: Has IPH 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 IPH’s historicals for more clarity.

  3. 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.