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Should You Be Tempted To Buy Spin Master Corp (TSE:TOY) Because Of Its PE Ratio?

I am writing today to help inform people who are new to the stock market and want to begin learning the link between Spin Master Corp (TSE:TOY)’s fundamentals and stock market performance.

Spin Master Corp (TSE:TOY) is currently trading at a trailing P/E of 27.3x, which is lower than the industry average of 27.3x. While this makes TOY 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 break down what the P/E ratio is, how to interpret it and what to watch out for.

What you need to know about 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 TOY

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

TOY Price-Earnings Ratio = \$42.89 ÷ \$1.57 = 27.3x

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 TOY, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 27.3x, TOY’s P/E is higher than its industry peers (25.6x). This implies that investors are overvaluing each dollar of TOY’s earnings. As such, our analysis shows that TOY represents an over-priced stock.

A few caveats

While our conclusion might prompt you to buy TOY immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to TOY. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with TOY, 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 TOY to are fairly valued by the market. If this does not hold, there is a possibility that TOY’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 rebalance your portfolio and reduce your holdings in TOY. 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:

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