Carpenter Technology Corporation (NYSE:CRS) is currently trading at a trailing P/E of 14.4x, which is higher than the industry average of 12x. While CRS might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Carpenter Technology
Demystifying the P/E 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 CRS
Price-Earnings Ratio = Price per share ÷ Earnings per share
CRS Price-Earnings Ratio = $49.2 ÷ $3.411 = 14.4x
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 CRS, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 14.4x, CRS’s P/E is higher than its industry peers (12x). This implies that investors are overvaluing each dollar of CRS’s earnings. Therefore, according to this analysis, CRS is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your CRS 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 CRS, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with CRS, 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 CRS to are fairly valued by the market. If this does not hold true, CRS’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 rebalance your portfolio and reduce your holdings in CRS. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for CRS’s future growth? Take a look at our free research report of analyst consensus for CRS’s outlook.
- Past Track Record: Has CRS 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 CRS’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.