Qantm Intellectual Property Limited ( ASX:QIP ) is currently trading at a trailing P/E of 28.1x, which is higher than the industry average of 19.6x. While QIP might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 QIP
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in 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 QIP
Price-Earnings Ratio = Price per share ÷ Earnings per share
QIP Price-Earnings Ratio = 1.52 ÷ 0.054 = 28.1x
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 QIP, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I'll do. At 28.1x, QIP's P/E is higher than its industry peers (19.6x). This implies that investors are overvaluing each dollar of QIP's earnings. Therefore, according to this analysis, QIP is an over-priced stock.
A few caveats
Before you jump to the conclusion that QIP 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 QIP, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with QIP, 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 QIP to are fairly valued by the market. If this does not hold, there is a possibility that QIP's P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder?If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in QIP. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor?If QIP has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Qantm Intellectual Property for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
