Should You Be Tempted To Sell Emerson Electric Co (NYSE:EMR) Because Of Its PE Ratio?
Emerson Electric Co (NYSE:EMR) trades with a trailing P/E of 25.7x, which is higher than the industry average of 18x. 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 Emerson Electric
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 EMR
Price-Earnings Ratio = Price per share ÷ Earnings per share
EMR Price-Earnings Ratio = $71.51 ÷ $2.784 = 25.7x
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 EMR, 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. At 25.7x, EMR’s P/E is higher than its industry peers (18x). This implies that investors are overvaluing each dollar of EMR’s earnings. Therefore, according to this analysis, EMR is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your EMR shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to EMR. 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 EMR, 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 EMR to are fairly valued by the market. If this does not hold, there is a possibility that EMR’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on EMR, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for EMR’s future growth? Take a look at our free research report of analyst consensus for EMR’s outlook.
Past Track Record: Has EMR 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 EMR’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 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.