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.
ManpowerGroup Inc (NYSE:MAN) trades with a trailing P/E of 8.7x, which is lower than the industry average of 23.9x. While this makes MAN appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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.
What you need to know about the P/E ratio
P/E is a popular ratio used for relative valuation. 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 MAN
Price-Earnings Ratio = Price per share ÷ Earnings per share
MAN Price-Earnings Ratio = $78.35 ÷ $8.972 = 8.7x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to MAN, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. MAN’s P/E of 8.7 is lower than its industry peers (23.9), which implies that each dollar of MAN’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Professional Services companies in US including Volt Information Sciences, Navigant Consulting and FTI Consulting. One could put it like this: the market is pricing MAN as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to MAN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with MAN, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing MAN to are fairly valued by the market. If this does not hold true, MAN’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to MAN. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for MAN’s future growth? Take a look at our free research report of analyst consensus for MAN’s outlook.
- Past Track Record: Has MAN 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 MAN’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 email@example.com.