Should You Sell L Brands Inc (NYSE:LB) At This PE Ratio?
L Brands Inc (NYSE:LB) is currently trading at a trailing P/E of 18.3x, which is higher than the industry average of 18x. While LB might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 L Brands
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 LB
Price-Earnings Ratio = Price per share ÷ Earnings per share
LB Price-Earnings Ratio = $61.02 ÷ $3.331 = 18.3x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as LB, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 18.3x, LB’s P/E is higher than its industry peers (18x). This implies that investors are overvaluing each dollar of LB’s earnings. As such, our analysis shows that LB represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your LB shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to LB. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with LB, 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 LB to are fairly valued by the market. If this does not hold, there is a possibility that LB’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in LB. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in LB, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 L Brands 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.
