Should You Sell AZZ Inc (AZZ) At This PE Ratio?
AZZ Inc (NYSE:AZZ) is trading with a trailing P/E of 23.8x, which is higher than the industry average of 23.3x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for AZZ
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 AZZ
Price-Earnings Ratio = Price per share ÷ Earnings per share
AZZ Price-Earnings Ratio = 48.7 ÷ 2.043 = 23.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to AZZ, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since AZZ's P/E of 23.8x is higher than its industry peers (23.3x), it means that investors are paying more than they should for each dollar of AZZ's earnings. Therefore, according to this analysis, AZZ is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your AZZ shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to AZZ, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with AZZ, 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 AZZ to are fairly valued by the market. If this does not hold true, AZZ’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? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to AZZ. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If you are considering investing in AZZ, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 AZZ 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.
