Is Finning International Inc (TSE:FTT) A Sell At Its Current PE Ratio?
Finning International Inc (TSX:FTT) trades with a trailing P/E of 33x, which is higher than the industry average of 26.6x. While this makes FTT 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Finning International
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 FTT
Price-Earnings Ratio = Price per share ÷ Earnings per share
FTT Price-Earnings Ratio = CA$32.19 ÷ CA$0.975 = 33x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 FTT, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since FTT’s P/E of 33x is higher than its industry peers (26.6x), it means that investors are paying more than they should for each dollar of FTT’s earnings. Therefore, according to this analysis, FTT is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your FTT shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to FTT, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with FTT, 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 FTT to are fairly valued by the market. If this is violated, FTT’s P/E may be lower than its peers as they are actually overvalued by investors.
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 overvaluation could signal a potential selling opportunity to reduce your exposure to FTT. 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 you are considering investing in FTT, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 Finning International 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.
