Alimentation Couche-Tard Inc (TSX:ATD.B) is trading with a trailing P/E of 15.3x, which is lower than the industry average of 16.8x. While this makes ATD.B appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Alimentation Couche-Tard
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 ATD.B
Price-Earnings Ratio = Price per share ÷ Earnings per share
ATD.B Price-Earnings Ratio = $41.58 ÷ $2.719 = 15.3x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as ATD.B, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 15.3x, ATD.B’s P/E is lower than its industry peers (16.8x). This implies that investors are undervaluing each dollar of ATD.B’s earnings. As such, our analysis shows that ATD.B represents an under-priced stock.
A few caveats
However, before you rush out to buy ATD.B, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to ATD.B, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with ATD.B, 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 ATD.B to are fairly valued by the market. If this does not hold true, ATD.B’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 add more of ATD.B to your portfolio. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for ATD.B’s future growth? Take a look at our free research report of analyst consensus for ATD.B’s outlook.
- Past Track Record: Has ATD.B 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 ATD.B’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.