Is It Time To Buy Sun Life Financial Inc (TSE:SLF) Based Off Its PE Ratio?
Sun Life Financial Inc (TSX:SLF) trades with a trailing P/E of 11.8x, which is lower than the industry average of 13x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. 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. Check out our latest analysis for Sun Life Financial
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 SLF
Price-Earnings Ratio = Price per share ÷ Earnings per share
SLF Price-Earnings Ratio = CA$51.57 ÷ CA$4.356 = 11.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 SLF, 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. Since SLF’s P/E of 11.8x is lower than its industry peers (13x), it means that investors are paying less than they should for each dollar of SLF’s earnings. As such, our analysis shows that SLF represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy SLF immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to SLF, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with SLF, 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 SLF to are fairly valued by the market. If this is violated, SLF’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on SLF, the undervaluation of the stock may mean it is a good time to top up on 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.
Are you a potential investor? If you are considering investing in SLF, 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 Sun Life Financial 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.
