Should You Buy Collins Foods Limited (ASX:CKF) At This PE Ratio?
Collins Foods Limited (ASX:CKF) trades with a trailing P/E of 21.3x, which is lower than the industry average of 26.6x. 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 Collins Foods
Breaking down the Price-Earnings 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 CKF
Price-Earnings Ratio = Price per share ÷ Earnings per share
CKF Price-Earnings Ratio = A$5.15 ÷ A$0.241 = 21.3x
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 CKF, 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 21.3x, CKF’s P/E is lower than its industry peers (26.6x). This implies that investors are undervaluing each dollar of CKF’s earnings. Therefore, according to this analysis, CKF is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy CKF immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to CKF, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with CKF, 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 CKF to are fairly valued by the market. If this is violated, CKF’s P/E may be lower than its peers as they are actually overvalued by investors.
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.
