This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Lennox International Inc (NYSE:LII) is currently trading at a trailing P/E of 29.1, which is higher than the industry average of 21.4. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Demystifying the P/E ratio
P/E is a popular ratio used for 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 LII
Price-Earnings Ratio = Price per share ÷ Earnings per share
LII Price-Earnings Ratio = $227.59 ÷ $7.824 = 29.1x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as LII, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. LII’s P/E of 29.1 is higher than its industry peers (21.4), which implies that each dollar of LII’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Building companies in US including Noda, Jewett-Cameron Trading and Masonite International. You could think of it like this: the market is pricing LII as if it is a stronger company than the average of its industry group.
A few caveats
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to LII. If not, the difference in P/E might be a result of other factors. For example, if Lennox International Inc is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to LII may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
Since you may have already conducted your due diligence on LII, the overvaluation of the stock may mean it is a good time to reduce 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:
- Future Outlook: What are well-informed industry analysts predicting for LII’s future growth? Take a look at our free research report of analyst consensus for LII’s outlook.
- Past Track Record: Has LII 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 LII’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.