Yahoo Finance Should You Buy Trustpower Limited (NZSE:TPW) At This PE Ratio?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Trustpower Limited (NZSE:TPW)’s fundamentals and stock market performance.
Trustpower Limited (NZSE:TPW) trades with a trailing P/E of 15.7x, which is lower than the industry average of 22.6x. While this makes TPW 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. See our latest analysis for Trustpower
Breaking down the P/E ratio
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.
P/E Calculation for TPW
Price-Earnings Ratio = Price per share ÷ Earnings per share
TPW Price-Earnings Ratio = NZ$5.64 ÷ NZ$0.360 = 15.7x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to TPW, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since TPW’s P/E of 15.7x is lower than its industry peers (22.6x), it means that investors are paying less than they should for each dollar of TPW’s earnings. Therefore, according to this analysis, TPW is an under-priced stock.
A few caveats
Before you jump to the conclusion that TPW is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to TPW. 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 TPW, 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 TPW to are fairly valued by the market. If this does not hold true, TPW’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of TPW to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 TPW’s future growth? Take a look at our free research report of analyst consensus for TPW’s outlook.
Past Track Record: Has TPW 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 TPW’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.
