Intact Financial Corporation (TSX:IFC) is trading with a trailing P/E of 16.8x, which is higher than the industry average of 15.8x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Intact Financial
Breaking down the P/E ratio
P/E is a popular ratio used for relative valuation. 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 IFC
Price-Earnings Ratio = Price per share ÷ Earnings per share
IFC Price-Earnings Ratio = CA$96.83 ÷ CA$5.748 = 16.8x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to IFC, 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. IFC’s P/E of 16.8x is higher than its industry peers (15.8x), which implies that each dollar of IFC’s earnings is being overvalued by investors. As such, our analysis shows that IFC represents an over-priced stock.
A few caveats
Before you jump to the conclusion that IFC 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 IFC. 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 IFC, 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 IFC to are fairly valued by the market. If this does not hold, there is a possibility that IFC’s P/E is lower because our peer group is overvalued by the market.
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.