FirstCash Inc (NYSE:FCFS) is currently trading at a trailing P/E of 27.6x, which is higher than the industry average of 12.7x. While this makes FCFS appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for FirstCash
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 FCFS
Price-Earnings Ratio = Price per share ÷ Earnings per share
FCFS Price-Earnings Ratio = 64.5 ÷ 2.337 = 27.6x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as FCFS, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 27.6x, FCFS’s P/E is higher than its industry peers (12.7x). This implies that investors are overvaluing each dollar of FCFS’s earnings. Therefore, according to this analysis, FCFS is an over-priced stock.
A few caveats
However, before you rush out to sell your FCFS shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to FCFS. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with FCFS, 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 FCFS to are fairly valued by the market. If this does not hold, there is a possibility that FCFS’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 FCFS, 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 FCFS, 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 FirstCash 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.