Should You Sell Sleep Country Canada Holdings Inc (TSE:ZZZ) At This PE Ratio?
Sleep Country Canada Holdings Inc (TSX:ZZZ) is trading with a trailing P/E of 25.1x, which is higher than the industry average of 14.5x. While ZZZ 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Sleep Country Canada Holdings
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 ZZZ
Price-Earnings Ratio = Price per share ÷ Earnings per share
ZZZ Price-Earnings Ratio = CA$36.99 ÷ CA$1.473 = 25.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ZZZ, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. ZZZ’s P/E of 25.1x is higher than its industry peers (14.5x), which implies that each dollar of ZZZ’s earnings is being overvalued by investors. As such, our analysis shows that ZZZ represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your ZZZ shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to ZZZ. 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 ZZZ, 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 ZZZ to are fairly valued by the market. If this does not hold true, ZZZ’s lower P/E ratio may be because firms in our peer group are 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.
