Cal-Maine Foods Inc (NASDAQ:CALM) is currently trading at a trailing P/E of 77.2x, which is higher than the industry average of 19x. While CALM 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. In this article, 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 Cal-Maine Foods
What you need to know about 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. 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 CALM
Price-Earnings Ratio = Price per share ÷ Earnings per share
CALM Price-Earnings Ratio = $47.35 ÷ $0.613 = 77.2x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CALM, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 77.2x, CALM’s P/E is higher than its industry peers (19x). This implies that investors are overvaluing each dollar of CALM’s earnings. Therefore, according to this analysis, CALM is an over-priced stock.
A few caveats
However, before you rush out to sell your CALM shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CALM. 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 CALM, 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 CALM to are fairly valued by the market. If this is violated, CALM’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on CALM, 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. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for CALM’s future growth? Take a look at our free research report of analyst consensus for CALM’s outlook.
- Past Track Record: Has CALM 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 CALM’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.