STEF SA. (ENXTPA:STF) is currently trading at a trailing P/E of 14x, which is lower than the industry average of 14.2x. While STF might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for STEF

What you need to know about 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 STF

Price-Earnings Ratio = Price per share ÷ Earnings per share

STF Price-Earnings Ratio = €106.8 ÷ €7.614 = 14x

On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to STF, 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. Since STF’s P/E of 14x is lower than its industry peers (14.2x), it means that investors are paying less than they should for each dollar of STF’s earnings. As such, our analysis shows that STF represents an under-priced stock.

Assumptions to watch out for

Before you jump to the conclusion that STF is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to STF, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with STF, 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 STF to are fairly valued by the market. If this does not hold true, STF’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 undervaluation could signal a good buying opportunity to increase your exposure to STF. 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 highly recommend you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for STF’s future growth? Take a look at our free research report of analyst consensus for STF’s outlook.

2. Past Track Record: Has STF 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 STF’s historicals for more clarity.

3. 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.