Should You Be Tempted To Buy Collins Foods Limited (ASX:CKF) At Its Current PE Ratio?
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Collins Foods Limited (ASX:CKF) trades with a trailing P/E of 19.9x, which is lower than the industry average of 24.7x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
See our latest analysis for Collins Foods
Breaking down the Price-Earnings 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 CKF
Price-Earnings Ratio = Price per share ÷ Earnings per share
CKF Price-Earnings Ratio = A$5.63 ÷ A$0.283 = 19.9x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CKF, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 19.9x, CKF’s P/E is lower than its industry peers (24.7x). This implies that investors are undervaluing each dollar of CKF’s earnings. This multiple is a median of profitable companies of 17 Hospitality companies in AU including Transmetro, Ainsworth Game Technology and SKYCITY Entertainment Group. As such, our analysis shows that CKF represents an under-priced stock.
A few caveats
However, before you rush out to buy CKF, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CKF. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with CKF, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing CKF to are fairly valued by the market. If this does not hold, there is a possibility that CKF’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of CKF to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for CKF’s future growth? Take a look at our free research report of analyst consensus for CKF’s outlook.
Past Track Record: Has CKF been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of CKF’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
