Deltic Timber Corporation (NYSE:DEL) is currently trading at a trailing P/E of 118x, which is higher than the industry average of 19.8x. 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 explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Deltic Timber
Demystifying the P/E ratio
P/E is a popular ratio used for 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 DEL
Price-Earnings Ratio = Price per share ÷ Earnings per share
DEL Price-Earnings Ratio = $91.5 ÷ $0.775 = 118x
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 DEL, 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 118x, DEL’s P/E is higher than its industry peers (19.8x). This implies that investors are overvaluing each dollar of DEL’s earnings. Therefore, according to this analysis, DEL is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that DEL should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to DEL. 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 DEL, 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 DEL to are fairly valued by the market. If this does not hold true, DEL’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to DEL. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If you are considering investing in DEL, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Deltic Timber for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.