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.
Cavco Industries Inc (NASDAQ:CVCO) trades with a trailing P/E of 30, which is higher than the industry average of 13. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down the P/E ratio
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 CVCO
Price-Earnings Ratio = Price per share ÷ Earnings per share
CVCO Price-Earnings Ratio = $230.31 ÷ $7.686 = 30x
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 CVCO, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since CVCO’s P/E of 30 is higher than its industry peers (13), it means that investors are paying more for each dollar of CVCO’s earnings. This multiple is a median of profitable companies of 25 Consumer Durables companies in US including Live Ventures, Newell Brands and LGI Homes. You could also say that the market is suggesting that CVCO is a stronger business than the average comparable company.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. The first is that our “similar companies” are actually similar to CVCO. If not, the difference in P/E might be a result of other factors. For example, if Cavco Industries Inc is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with CVCO are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
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 CVCO. 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 CVCO’s future growth? Take a look at our free research report of analyst consensus for CVCO’s outlook.
- Past Track Record: Has CVCO 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 CVCO’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.