Should You Sell United Rentals Inc (NYSE:URI) At This PE Ratio?
United Rentals Inc (NYSE:URI) is trading with a trailing P/E of 24.4x, which is higher than the industry average of 17.8x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for United Rentals
Breaking down the Price-Earnings 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 URI
Price-Earnings Ratio = Price per share ÷ Earnings per share
URI Price-Earnings Ratio = $173.58 ÷ $7.122 = 24.4x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to URI, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since URI’s P/E of 24.4x is higher than its industry peers (17.8x), it means that investors are paying more than they should for each dollar of URI’s earnings. Therefore, according to this analysis, URI is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your URI 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 URI. 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 URI, 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 URI to are fairly valued by the market. If this is violated, URI’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? 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 URI. 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 URI, 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 United Rentals 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.
