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Should You Be Tempted To Buy MDC Holdings Inc (NYSE:MDC) At Its Current PE Ratio?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

MDC Holdings Inc (NYSE:MDC) is trading with a trailing P/E of 8.8x, which is lower than the industry average of 13x. While this makes MDC 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 explain what the P/E ratio is as well as what you should look out for when using it.

See our latest analysis for M.D.C. Holdings

Breaking down the P/E ratio

NYSE:MDC PE PEG Gauge September 28th 18
NYSE:MDC PE PEG Gauge September 28th 18

P/E is often used for relative valuation since earnings power is a chief 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 MDC

Price-Earnings Ratio = Price per share ÷ Earnings per share

MDC Price-Earnings Ratio = $29.51 ÷ $3.353 = 8.8x

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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as MDC, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. MDC’s P/E of 8.8 is lower than its industry peers (13), which implies that each dollar of MDC’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Consumer Durables companies in US including Live Ventures, Samson Holding and Newell Brands. You can think of it like this: the market is suggesting that MDC is a weaker business than the average comparable company.

Assumptions to be aware of

Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to MDC. 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 MDC, 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 MDC to are fairly valued by the market. If this does not hold, there is a possibility that MDC’s P/E is lower because our peer group is overvalued by the market.

What this means for you:

Since you may have already conducted your due diligence on MDC, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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:

  1. Future Outlook: What are well-informed industry analysts predicting for MDC’s future growth? Take a look at our free research report of analyst consensus for MDC’s outlook.

  2. Past Track Record: Has MDC 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 MDC’s historicals for more clarity.

  3. 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.

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