Is It Time To Sell Canadian Solar Inc (NASDAQ:CSIQ) Based Off Its PE Ratio?
Canadian Solar Inc (NASDAQ:CSIQ) is currently trading at a trailing P/E of 39.4x, which is higher than the industry average of 20.3x. While CSIQ 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Canadian Solar
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 CSIQ
Price-Earnings Ratio = Price per share ÷ Earnings per share
CSIQ Price-Earnings Ratio = $16.86 ÷ $0.428 = 39.4x
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 CSIQ, 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 CSIQ’s P/E of 39.4x is higher than its industry peers (20.3x), it means that investors are paying more than they should for each dollar of CSIQ’s earnings. As such, our analysis shows that CSIQ represents an over-priced stock.
A few caveats
However, before you rush out to sell your CSIQ shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CSIQ. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with CSIQ, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing CSIQ to are fairly valued by the market. If this is violated, CSIQ’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 CSIQ, 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.
Are you a potential investor? If CSIQ has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
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 Canadian Solar 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.
