Dunkin’ Brands Group Inc (NASDAQ:DNKN) trades with a trailing P/E of 15.8x, which is lower than the industry average of 21.7x. While this makes DNKN appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Dunkin’ Brands Group
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 DNKN
Price-Earnings Ratio = Price per share ÷ Earnings per share
DNKN Price-Earnings Ratio = $60.92 ÷ $3.862 = 15.8x
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 DNKN, 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. DNKN’s P/E of 15.8x is lower than its industry peers (21.7x), which implies that each dollar of DNKN’s earnings is being undervalued by investors. As such, our analysis shows that DNKN represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy DNKN immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to DNKN. 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 DNKN, 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 DNKN to are fairly valued by the market. If this does not hold, there is a possibility that DNKN’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to DNKN. 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. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for DNKN’s future growth? Take a look at our free research report of analyst consensus for DNKN’s outlook.
- Past Track Record: Has DNKN been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of DNKN’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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.