This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
HNI Corporation (NYSE:HNI) is currently trading at a trailing P/E of 18.2, which is close to the industry average of 18.5. While this makes HNI 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.
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 HNI
Price-Earnings Ratio = Price per share ÷ Earnings per share
HNI Price-Earnings Ratio = $38.61 ÷ $2.118 = 18.2x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to HNI, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. HNI Corporation (NYSE:HNI) trades on a trailing P/E of 18.2. This isn’t too far from the industry average (which is 18.5). This multiple is a median of profitable companies of 24 Commercial Services companies in US including Pointer Telocation, Covanta Holding and McGrath RentCorp. You can think of it like this: the market is suggesting that HNI has similar prospects to its peers in the same industry.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to HNI. 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 HNI, 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 HNI to are fairly valued by the market. If this does not hold true, HNI’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on HNI, 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for HNI’s future growth? Take a look at our free research report of analyst consensus for HNI’s outlook.
- Past Track Record: Has HNI 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 HNI’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 past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.