This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in James Hardie Industries plc (ASX:JHX).
James Hardie Industries plc (ASX:JHX) is currently trading at a trailing P/E of 49.9x, which is higher than the industry average of 24.6x. While JHX might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 James Hardie Industries
Demystifying the P/E 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 JHX
Price-Earnings Ratio = Price per share ÷ Earnings per share
JHX Price-Earnings Ratio = $16.51 ÷ $0.331 = 49.9x
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 JHX, 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. At 49.9x, JHX’s P/E is higher than its industry peers (24.6x). This implies that investors are overvaluing each dollar of JHX’s earnings. Therefore, according to this analysis, JHX is an over-priced stock.
A few caveats
Before you jump to the conclusion that JHX 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 JHX, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with JHX, 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 JHX to are fairly valued by the market. If this does not hold true, JHX’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 JHX. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for JHX’s future growth? Take a look at our free research report of analyst consensus for JHX’s outlook.
- Past Track Record: Has JHX 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 JHX’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.