Does T Rowe Price Group Inc’s (TROW) PE Ratio Signal A Buying Opportunity?
T Rowe Price Group Inc (NASDAQ:TROW) trades with a trailing P/E of 16.4x, which is lower than the industry average of 18.8x. While this makes TROW appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 TROW
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 TROW
Price-Earnings Ratio = Price per share ÷ Earnings per share
TROW Price-Earnings Ratio = 96.86 ÷ 5.914 = 16.4x
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 TROW, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. TROW’s P/E of 16.4x is lower than its industry peers (18.8x), which implies that each dollar of TROW’s earnings is being undervalued by investors. As such, our analysis shows that TROW represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy TROW immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to TROW. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with TROW, 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 TROW to are fairly valued by the market. If this does not hold, there is a possibility that TROW’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to TROW. 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.
Are you a potential investor? If TROW has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on T. Rowe Price Group for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
