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 learn about the link between company’s fundamentals and stock market performance.
Premium Brands Holdings Corporation (TSE:PBH) is currently trading at a trailing P/E of 37.3x, which is higher than the industry average of 19.7x. While PBH 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down 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 PBH
Price-Earnings Ratio = Price per share ÷ Earnings per share
PBH Price-Earnings Ratio = CA$100.42 ÷ CA$2.69 = 37.3x
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 PBH, 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. PBH’s P/E of 37.3x is higher than its industry peers (19.7x), which implies that each dollar of PBH’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 10 Food companies in CA including Inter-Rock Minerals, Imperial Ginseng Products and High Liner Foods. As such, our analysis shows that PBH represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your PBH shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to PBH, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with PBH, 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 PBH to are fairly valued by the market. If this is violated, PBH’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 PBH, 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for PBH’s future growth? Take a look at our free research report of analyst consensus for PBH’s outlook.
- Past Track Record: Has PBH 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 PBH’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 firstname.lastname@example.org.