CubeSmart (NYSE:CUBE) is trading with a trailing P/E of 39.7x, which is higher than the industry average of 21.4x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for CubeSmart
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in 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 CUBE
Price-Earnings Ratio = Price per share ÷ Earnings per share
CUBE Price-Earnings Ratio = $26.05 ÷ $0.656 = 39.7x
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 CUBE, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 39.7x, CUBE’s P/E is higher than its industry peers (21.4x). This implies that investors are overvaluing each dollar of CUBE’s earnings. Therefore, according to this analysis, CUBE is an over-priced stock.
A few caveats
Before you jump to the conclusion that CUBE should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to CUBE, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with CUBE, 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 CUBE to are fairly valued by the market. If this is violated, CUBE’s P/E may be lower than its peers as they are actually overvalued by investors.
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.