AMREP Corporation (NYSE:AXR) trades with a trailing P/E of 70.6x, which is higher than the industry average of 12.1x. 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 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 AMREP
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. 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 AXR
Price-Earnings Ratio = Price per share ÷ Earnings per share
AXR Price-Earnings Ratio = $7.04 ÷ $0.1 = 70.6x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to AXR, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since AXR’s P/E of 70.6x is higher than its industry peers (12.1x), it means that investors are paying more than they should for each dollar of AXR’s earnings. As such, our analysis shows that AXR represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your AXR shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to AXR, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with AXR, 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 AXR to are fairly valued by the market. If this does not hold true, AXR’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? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to AXR. 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.
Are you a potential investor? If AXR 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 AMREP 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.