Is Canadian Pacific Railway Limited’s (TSE:CP) PE Ratio A Signal To Buy For Investors?
Canadian Pacific Railway Limited (TSX:CP) trades with a trailing P/E of 14.6x, which is lower than the industry average of 16.8x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Canadian Pacific Railway
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 CP
Price-Earnings Ratio = Price per share ÷ Earnings per share
CP Price-Earnings Ratio = CA$233.52 ÷ CA$15.972 = 14.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 CP, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since CP’s P/E of 14.6x is lower than its industry peers (16.8x), it means that investors are paying less than they should for each dollar of CP’s earnings. As such, our analysis shows that CP represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy CP immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to CP. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with CP, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing CP to are fairly valued by the market. If this does not hold true, CP’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of CP to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for CP’s future growth? Take a look at our free research report of analyst consensus for CP’s outlook.
Past Track Record: Has CP 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 CP’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.
