Baldwin & Lyons Inc (NASDAQ:BWIN.B) trades with a trailing P/E of 53.2x, which is higher than the industry average of 17.3x. While this makes BWIN.B 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 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 Baldwin & Lyons
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 BWIN.B
Price-Earnings Ratio = Price per share ÷ Earnings per share
BWIN.B Price-Earnings Ratio = $23.65 ÷ $0.445 = 53.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to BWIN.B, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. BWIN.B’s P/E of 53.2x is higher than its industry peers (17.3x), which implies that each dollar of BWIN.B’s earnings is being overvalued by investors. As such, our analysis shows that BWIN.B represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that BWIN.B should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to BWIN.B, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with BWIN.B, 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 BWIN.B to are fairly valued by the market. If this is violated, BWIN.B’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on BWIN.B, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above.
Are you a potential investor? If you are considering investing in BWIN.B, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Baldwin & Lyons for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.