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Does Sterling Construction Company Inc’s (NASDAQ:STRL) PE Ratio Warrant A Sell?

Jacob Boyd

I am writing today to help inform people who are new to the stock market and want to begin learning the link between Sterling Construction Company Inc (NASDAQ:STRL)’s fundamentals and stock market performance.

Sterling Construction Company Inc (NASDAQ:STRL) is currently trading at a trailing P/E of 22.2x, which is higher than the industry average of 17.4x. 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. See our latest analysis for Sterling Construction Company

What you need to know about the P/E ratio

NasdaqGS:STRL PE PEG Gauge June 25th 18

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 STRL

Price-Earnings Ratio = Price per share ÷ Earnings per share

STRL Price-Earnings Ratio = $13.59 ÷ $0.612 = 22.2x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as STRL, 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 STRL’s P/E of 22.2x is higher than its industry peers (17.4x), it means that investors are paying more than they should for each dollar of STRL’s earnings. Therefore, according to this analysis, STRL is an over-priced stock.

Assumptions to be aware of

Before you jump to the conclusion that STRL should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to STRL, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with STRL, 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 STRL to are fairly valued by the market. If this does not hold, there is a possibility that STRL’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 STRL. 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 highly recommend you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for STRL’s future growth? Take a look at our free research report of analyst consensus for STRL’s outlook.
  2. Past Track Record: Has STRL 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 STRL’s historicals for more clarity.
  3. 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.