Renishaw plc (LSE:RSW) is trading with a trailing P/E of 29.9x, which is higher than the industry average of 18x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Renishaw
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 RSW
Price-Earnings Ratio = Price per share ÷ Earnings per share
RSW Price-Earnings Ratio = £56.4 ÷ £1.889 = 29.9x
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 RSW, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. RSW’s P/E of 29.9x is higher than its industry peers (18x), which implies that each dollar of RSW’s earnings is being overvalued by investors. Therefore, according to this analysis, RSW is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that RSW should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to RSW, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with RSW, 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 RSW to are fairly valued by the market. If this does not hold true, RSW’s lower P/E ratio may be because firms in our peer group are 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 overvaluation could signal a potential selling opportunity to reduce your exposure to RSW. 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:
- Future Outlook: What are well-informed industry analysts predicting for RSW’s future growth? Take a look at our free research report of analyst consensus for RSW’s outlook.
- Past Track Record: Has RSW 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 RSW’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.