MYOB Group Limited ( ASX:MYO ) trades with a trailing P/E of 35x, which is higher than the industry average of 32.4x. While MYO 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for MYOB Group
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 MYO
Price-Earnings Ratio = Price per share ÷ Earnings per share
MYO Price-Earnings Ratio = 3.36 ÷ 0.096 = 35x
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 MYO, 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. MYO's P/E of 35x is higher than its industry peers (32.4x), which implies that each dollar of MYO's earnings is being overvalued by investors. Therefore, according to this analysis, MYO is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your MYO shares immediately, there are two important assumptions you should be aware of. The first is that our "similar companies" are actually similar to MYO, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with MYO, 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 MYO to are fairly valued by the market. If this does not hold true, MYO's lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder?Since you may have already conducted your due diligence on MYO, the overvaluation of the stock may mean it is a good time to reduce 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.
Are you a potential investor?If you are considering investing in MYO, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 MYOB Group 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.
