Should You Be Tempted To Buy Consumer Portfolio Services Inc (NASDAQ:CPSS) At Its Current PE Ratio?
Consumer Portfolio Services Inc (NASDAQ:CPSS) trades with a trailing P/E of 4.5x, which is lower than the industry average of 13.8x. 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 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 Consumer Portfolio Services
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 CPSS
Price-Earnings Ratio = Price per share ÷ Earnings per share
CPSS Price-Earnings Ratio = $4.07 ÷ $0.913 = 4.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to CPSS, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. CPSS’s P/E of 4.5x is lower than its industry peers (13.8x), which implies that each dollar of CPSS’s earnings is being undervalued by investors. Therefore, according to this analysis, CPSS is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy CPSS immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to CPSS, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with CPSS, 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 CPSS to are fairly valued by the market. If this is violated, CPSS’s P/E may be lower than its peers as they are actually overvalued by investors.
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.
