At £22.53, Is It Time To Sell Bunzl plc (LSE:BNZL)?
Bunzl plc (LSE:BNZL) is trading with a trailing P/E of 25.9x, which is higher than the industry average of 16.4x. 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. Today, 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 BNZL
Demystifying 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 pound of the company’s earnings.
P/E Calculation for BNZL
Price-Earnings Ratio = Price per share ÷ Earnings per share
BNZL Price-Earnings Ratio = 22.53 ÷ 0.869 = 25.9x
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 BNZL, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. BNZL’s P/E of 25.9x is higher than its industry peers (16.4x), which implies that each dollar of BNZL’s earnings is being overvalued by investors. As such, our analysis shows that BNZL represents an over-priced stock.
A few caveats
Before you jump to the conclusion that BNZL 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 BNZL, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with BNZL, 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 BNZL to are fairly valued by the market. If this does not hold, there is a possibility that BNZL’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on BNZL, 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 BNZL 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 Bunzl 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.
