Yahoo Finance Is GKN plc (LON:GKN) A Buy At Its Current PE Ratio?
GKN plc (LSE:GKN) trades with a trailing P/E of 16.4x, which is lower than the industry average of 17.8x. While this makes GKN appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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 GKN
Demystifying 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 pound of the company’s earnings.
P/E Calculation for GKN
Price-Earnings Ratio = Price per share ÷ Earnings per share
GKN Price-Earnings Ratio = £4.82 ÷ £0.293 = 16.4x
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 GKN, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 16.4x, GKN’s P/E is lower than its industry peers (17.8x). This implies that investors are undervaluing each dollar of GKN’s earnings. As such, our analysis shows that GKN represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy GKN immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to GKN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with GKN, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing GKN to are fairly valued by the market. If this is violated, GKN’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 GKN, 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 highly recommend you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for GKN’s future growth? Take a look at our free research report of analyst consensus for GKN’s outlook.
Past Track Record: Has GKN 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 GKN’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 pass 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.
