Graham Holdings Company (NYSE:GHC) trades with a trailing P/E of 11.2x, which is lower than the industry average of 20.4x. While GHC 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Graham Holdings
Breaking down 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. 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 GHC
Price-Earnings Ratio = Price per share ÷ Earnings per share
GHC Price-Earnings Ratio = $609.4 ÷ $54.244 = 11.2x
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 GHC, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. GHC’s P/E of 11.2x is lower than its industry peers (20.4x), which implies that each dollar of GHC’s earnings is being undervalued by investors. Therefore, according to this analysis, GHC is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy GHC immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to GHC, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with GHC, 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 GHC to are fairly valued by the market. If this does not hold, there is a possibility that GHC’s P/E is lower because our peer group is overvalued by the market.
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.