First Capital Realty Inc (TSX:FCR) trades with a trailing P/E of 7.9x, which is lower than the industry average of 10.8x. While FCR might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 First Capital Realty
Breaking down the P/E 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 FCR
Price-Earnings Ratio = Price per share ÷ Earnings per share
FCR Price-Earnings Ratio = CA$20.37 ÷ CA$2.587 = 7.9x
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 FCR, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. FCR’s P/E of 7.9x is lower than its industry peers (10.8x), which implies that each dollar of FCR’s earnings is being undervalued by investors. As such, our analysis shows that FCR represents an under-priced stock.
A few caveats
However, before you rush out to buy FCR, 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 FCR, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with FCR, 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 FCR to are fairly valued by the market. If this is violated, FCR’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on FCR, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is FCR’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has FCR 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 FCR’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 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.