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Despite Its High P/E Ratio, Is CanWel Building Materials Group Ltd. (TSE:CWX) Still Undervalued?

Alex Johannesen

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how CanWel Building Materials Group Ltd.’s (TSE:CWX) P/E ratio could help you assess the value on offer. Based on the last twelve months, CanWel Building Materials Group’s P/E ratio is 11.19. In other words, at today’s prices, investors are paying CA$11.19 for every CA$1 in prior year profit.

See our latest analysis for CanWel Building Materials Group

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for CanWel Building Materials Group:

P/E of 11.19 = CA$5.1 ÷ CA$0.46 (Based on the year to September 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CA$1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

CanWel Building Materials Group saw earnings per share improve by -3.8% last year. And it has bolstered its earnings per share by 11% per year over the last five years. In contrast, EPS has decreased by 3.7%, annually, over 3 years.

How Does CanWel Building Materials Group’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that CanWel Building Materials Group has a P/E ratio that is roughly in line with the trade distributors industry average (10.6).

TSX:CWX PE PEG Gauge February 4th 19

Its P/E ratio suggests that CanWel Building Materials Group shareholders think that in the future it will perform about the same as other companies in its industry classification. So if CanWel Building Materials Group actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

CanWel Building Materials Group’s Balance Sheet

CanWel Building Materials Group has net debt worth 68% of its market capitalization. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.

The Verdict On CanWel Building Materials Group’s P/E Ratio

CanWel Building Materials Group’s P/E is 11.2 which is below average (14.3) in the CA market. The meaningful debt load is probably contributing to low expectations, even though it has improved earnings recently.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than CanWel Building Materials Group. So you may wish to see this free collection of other companies that have grown earnings strongly.

To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.