MCBC Holdings Inc (NASDAQ:MCFT) is trading with a trailing P/E of 20x, which is higher than the industry average of 19x. 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for MCFT
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 MCFT
Price-Earnings Ratio = Price per share ÷ Earnings per share
MCFT Price-Earnings Ratio = 21.05 ÷ 1.053 = 20x
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 MCFT, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since MCFT's P/E of 20x is higher than its industry peers (19x), it means that investors are paying more than they should for each dollar of MCFT's earnings. Therefore, according to this analysis, MCFT is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your MCFT shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to MCFT, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with MCFT, 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 MCFT to are fairly valued by the market. If this is violated, MCFT's P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on MCFT, 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.
Are you a potential investor? If you are considering investing in MCFT, 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 MCBC Holdings 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.