Flexible Solutions International Inc (AMEX:FSI) trades with a trailing P/E of 5.7x, which is lower than the industry average of 21.1x. While FSI 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. 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 Flexible Solutions International
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 FSI
Price-Earnings Ratio = Price per share ÷ Earnings per share
FSI Price-Earnings Ratio = $1.82 ÷ $0.318 = 5.7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 FSI, 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 5.7x, FSI’s P/E is lower than its industry peers (21.1x). This implies that investors are undervaluing each dollar of FSI’s earnings. As such, our analysis shows that FSI represents an under-priced stock.
A few caveats
However, before you rush out to buy FSI, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to FSI, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with FSI, 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 FSI to are fairly valued by the market. If this is violated, FSI’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? 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 FSI 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.
Are you a potential investor? If you are considering investing in FSI, 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 Flexible Solutions International 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.