Cenovus Energy Inc (TSX:CVE) is trading with a trailing P/E of 4.7x, which is lower than the industry average of 23.4x. While CVE might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for CVE
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 CVE
Price-Earnings Ratio = Price per share ÷ Earnings per share
CVE Price-Earnings Ratio = 12.99 ÷ 2.776 = 4.7x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to CVE, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 4.7x, CVE’s P/E is lower than its industry peers (23.4x). This implies that investors are undervaluing each dollar of CVE’s earnings. As such, our analysis shows that CVE represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy CVE, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CVE. 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 CVE, 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 CVE to are fairly valued by the market. If this does not hold, there is a possibility that CVE’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on CVE, the undervaluation of the stock may mean it is a good time to top up on 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 CVE, 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 Cenovus Energy 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.