Constellation Software Inc (TSX:CSU) is currently trading at a trailing P/E of 65.5x, which is higher than the industry average of 36.4x. While this makes CSU 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Constellation Software
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 CSU
Price-Earnings Ratio = Price per share ÷ Earnings per share
CSU Price-Earnings Ratio = $685.92 ÷ $10.474 = 65.5x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CSU, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since CSU’s P/E of 65.5x is higher than its industry peers (36.4x), it means that investors are paying more than they should for each dollar of CSU’s earnings. Therefore, according to this analysis, CSU is an over-priced stock.
A few caveats
However, before you rush out to sell your CSU shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CSU. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with CSU, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CSU to are fairly valued by the market. If this does not hold, there is a possibility that CSU’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.