Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Commercial Vehicle Group, Inc.'s (NASDAQ:CVGI) P/E ratio to inform your assessment of the investment opportunity. Commercial Vehicle Group has a price to earnings ratio of 5.62, based on the last twelve months. That corresponds to an earnings yield of approximately 18%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Commercial Vehicle Group:
P/E of 5.62 = $7.35 ÷ $1.31 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
How Does Commercial Vehicle Group's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Commercial Vehicle Group has a lower P/E than the average (19.8) in the machinery industry classification.
Its relatively low P/E ratio indicates that Commercial Vehicle Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Commercial Vehicle Group, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
In the last year, Commercial Vehicle Group grew EPS like Taylor Swift grew her fan base back in 2010; the 91% gain was both fast and well deserved. And earnings per share have improved by 91% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Commercial Vehicle Group's Balance Sheet
Commercial Vehicle Group's net debt equates to 42% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Commercial Vehicle Group's P/E Ratio
Commercial Vehicle Group's P/E is 5.6 which is below average (17.4) in the US market. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.