Should You Be Tempted To Buy Schnitzer Steel Industries Inc (NASDAQ:SCHN) Because Of Its PE Ratio?
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Schnitzer Steel Industries Inc (NASDAQ:SCHN) is currently trading at a trailing P/E of 6.4x, which is lower than the industry average of 12.6x. While SCHN 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
View our latest analysis for Schnitzer Steel Industries
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 SCHN
Price-Earnings Ratio = Price per share ÷ Earnings per share
SCHN Price-Earnings Ratio = $26.63 ÷ $4.153 = 6.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SCHN, 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. Since SCHN’s P/E of 6.4 is lower than its industry peers (12.6), it means that investors are paying less for each dollar of SCHN’s earnings. This multiple is a median of profitable companies of 24 Metals and Mining companies in US including Nuinsco Resources, Ossen Innovation and Nevada Canyon Gold. One could put it like this: the market is pricing SCHN as if it is a weaker company than the average company in its industry.
A few caveats
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. The first is that our “similar companies” are actually similar to SCHN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with SCHN, 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 SCHN to are fairly valued by the market. If this does not hold, there is a possibility that SCHN’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
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 SCHN 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. 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:
Future Outlook: What are well-informed industry analysts predicting for SCHN’s future growth? Take a look at our free research report of analyst consensus for SCHN’s outlook.
Past Track Record: Has SCHN 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 SCHN’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 editorial-team@simplywallst.com.
