Does Steel Dynamics Inc’s (NASDAQ:STLD) PE Ratio Warrant A Buy?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Steel Dynamics Inc (NASDAQ:STLD) trades on a trailing P/E of 10.4. This isn’t too far from the industry average (which is 10.7). Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
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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 STLD
Price-Earnings Ratio = Price per share ÷ Earnings per share
STLD Price-Earnings Ratio = $45.79 ÷ $4.42 = 10.4x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to STLD, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Steel Dynamics Inc (NASDAQ:STLD) is trading with a trailing P/E of 10.4, which is close to the industry average of 10.7. This multiple is a median of profitable companies of 25 Metals and Mining companies in US including North American Potash Developments, Société d’Exploration Minière Vior and Nuinsco Resources. You can think of it like this: the market is suggesting that STLD has similar prospects to its peers in the same industry.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to STLD. 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 STLD, 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 STLD to are fairly valued by the market. If this does not hold true, STLD’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on STLD, the undervaluation of the stock may mean it is a good time to top up on 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 STLD’s future growth? Take a look at our free research report of analyst consensus for STLD’s outlook.
Past Track Record: Has STLD 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 STLD’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 editorial-team@simplywallst.com.
