Aaron’s Inc (NYSE:AAN) trades with a trailing P/E of 11.7x, which is lower than the industry average of 18.7x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Aaron’s
Breaking down the Price-Earnings 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 AAN
Price-Earnings Ratio = Price per share ÷ Earnings per share
AAN Price-Earnings Ratio = $48.32 ÷ $4.13 = 11.7x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as AAN, 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. At 11.7x, AAN’s P/E is lower than its industry peers (18.7x). This implies that investors are undervaluing each dollar of AAN’s earnings. As such, our analysis shows that AAN represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy AAN immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to AAN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with AAN, 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 AAN to are fairly valued by the market. If this does not hold, there is a possibility that AAN’s P/E is lower because our peer group is overvalued by the market.
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.