Campbell Soup Company (NYSE:CPB) trades with a trailing P/E of 20.7x, which is higher than the industry average of 19.4x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Campbell Soup
Demystifying the P/E ratio
P/E is a popular ratio used for 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 CPB
Price-Earnings Ratio = Price per share ÷ Earnings per share
CPB Price-Earnings Ratio = $33.33 ÷ $1.61 = 20.7x
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. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CPB, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since CPB’s P/E of 20.7x is higher than its industry peers (19.4x), it means that investors are paying more than they should for each dollar of CPB’s earnings. Therefore, according to this analysis, CPB is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your CPB shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to CPB. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with CPB, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CPB to are fairly valued by the market. If this does not hold true, CPB’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to CPB. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 CPB’s future growth? Take a look at our free research report of analyst consensus for CPB’s outlook.
- Past Track Record: Has CPB 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 CPB’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.