First Capital Realty Inc (TSX:FCR) is trading with a trailing P/E of 8.2x, which is lower than the industry average of 9.3x. While this makes FCR 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for First Capital Realty
Demystifying the P/E ratio
P/E is a popular ratio used for 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 FCR
Price-Earnings Ratio = Price per share ÷ Earnings per share
FCR Price-Earnings Ratio = CA$20.61 ÷ CA$2.519 = 8.2x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to FCR, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. FCR’s P/E of 8.2x is lower than its industry peers (9.3x), 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. Firstly, our peer group contains companies that are similar to FCR. 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 FCR, 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 FCR to are fairly valued by the market. If this does not hold true, FCR’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of FCR to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If FCR 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 First Capital Realty 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.