Does The Home Depot Inc’s (NYSE:HD) PE Ratio Warrant A Sell?
The Home Depot Inc (NYSE:HD) trades with a trailing P/E of 24.2x, which is higher than the industry average of 19.4x. While HD 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 Home Depot
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 HD
Price-Earnings Ratio = Price per share ÷ Earnings per share
HD Price-Earnings Ratio = $186.87 ÷ $7.733 = 24.2x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to HD, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since HD’s P/E of 24.2x is higher than its industry peers (19.4x), it means that investors are paying more than they should for each dollar of HD’s earnings. Therefore, according to this analysis, HD is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your HD shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to HD, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with HD, 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 HD to are fairly valued by the market. If this does not hold, there is a possibility that HD’s P/E is lower because our peer group is 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 HD. 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 HD’s future growth? Take a look at our free research report of analyst consensus for HD’s outlook.
Past Track Record: Has HD 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 HD’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.
