The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Caisse Régionale de Crédit Agricole Mutuel de Paris et d’Ile-de-France (EPA:CAF) is currently trading at a trailing P/E of 9.7, which is higher than the industry average of 8.9. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. 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.
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 CAF
Price-Earnings Ratio = Price per share ÷ Earnings per share
CAF Price-Earnings Ratio = €90.45 ÷ €9.372 = 9.7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to CAF, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since CAF’s P/E of 9.7 is higher than its industry peers (8.9), it means that investors are paying more for each dollar of CAF’s earnings. This multiple is a median of profitable companies of 16 Banks companies in FR including Caisse Régionale de Crédit Agricole Mutuel du Languedoc, Caisse Régionale de Crédit Agricole Brie Picardie and Caisse Regionale de Credit Agricole Mutuel de la Loire-Haute-Loire. You could think of it like this: the market is pricing CAF as if it is a stronger company than the average of its industry group.
A few caveats
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to CAF. If this isn’t the case, the difference in P/E could be due to other factors. For example, Caisse Régionale de Crédit Agricole Mutuel de Paris et d’Ile-de-France could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to CAF may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
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 CAF. 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 CAF’s future growth? Take a look at our free research report of analyst consensus for CAF’s outlook.
- Past Track Record: Has CAF 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 CAF’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 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 email@example.com.