CVR Energy Inc (NYSE:CVI) is currently trading at a trailing P/E of 13.2x, which is higher than the industry average of 12.8x. While this makes CVI appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for CVR Energy
What you need to know about the P/E 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 CVI
Price-Earnings Ratio = Price per share ÷ Earnings per share
CVI Price-Earnings Ratio = $35.55 ÷ $2.7 = 13.2x
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 CVI, 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 CVI’s P/E of 13.2x is higher than its industry peers (12.8x), it means that investors are paying more than they should for each dollar of CVI’s earnings. As such, our analysis shows that CVI represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your CVI shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to CVI. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with CVI, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing CVI to are fairly valued by the market. If this does not hold true, CVI’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 CVI. 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:
- Financial Health: Is CVI’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has CVI 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 CVI’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.