James Hardie Industries plc (ASX:JHX) is currently trading at a trailing P/E of 30.3x, which is higher than the industry average of 29.5x. While this makes JHX 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for James Hardie Industries
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 JHX
Price-Earnings Ratio = Price per share ÷ Earnings per share
JHX Price-Earnings Ratio = $17.61 ÷ $0.581 = 30.3x
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 JHX, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since JHX’s P/E of 30.3x is higher than its industry peers (29.5x), it means that investors are paying more than they should for each dollar of JHX’s earnings. As such, our analysis shows that JHX represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your JHX shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to JHX. 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 JHX, 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 JHX to are fairly valued by the market. If this does not hold, there is a possibility that JHX’s P/E is lower because our peer group is overvalued by the market.
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.