Does WH Smith PLC’s (LON:SMWH) PE Ratio Signal A Selling Opportunity?
I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
WH Smith PLC (LON:SMWH) is currently trading at a trailing P/E of 19.4x, which is higher than the industry average of 11.7x. While this makes SMWH appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Check out our latest analysis for WH Smith
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 SMWH
Price-Earnings Ratio = Price per share ÷ Earnings per share
SMWH Price-Earnings Ratio = £20.12 ÷ £1.036 = 19.4x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SMWH, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. SMWH’s P/E of 19.4x is higher than its industry peers (11.7x), which implies that each dollar of SMWH’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 24 Specialty Retail companies in GB including United Carpets Group, Cambria Automobiles and ScS Group. As such, our analysis shows that SMWH represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your SMWH shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to SMWH. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with SMWH, 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 SMWH to are fairly valued by the market. If this is violated, SMWH’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in SMWH. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 SMWH’s future growth? Take a look at our free research report of analyst consensus for SMWH’s outlook.
Past Track Record: Has SMWH 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 SMWH’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.
