Federated Investors Inc (NYSE:FII) is currently trading at a trailing P/E of 11.5x, which is lower than the industry average of 16.6x. 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 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 Federated Investors
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 FII
Price-Earnings Ratio = Price per share ÷ Earnings per share
FII Price-Earnings Ratio = $33.12 ÷ $2.874 = 11.5x
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 FII, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. FII’s P/E of 11.5x is lower than its industry peers (16.6x), which implies that each dollar of FII’s earnings is being undervalued by investors. As such, our analysis shows that FII represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that FII is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to FII. 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 FII, 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 FII to are fairly valued by the market. If this is violated, FII’s P/E may be lower than its peers as they are actually overvalued by investors.
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.