Is It Time To Sell Constellation Software Inc (TSX:CSU) Based Off Its PE Ratio?
Constellation Software Inc (TSX:CSU) trades with a trailing P/E of 57.4x, which is higher than the industry average of 46.7x. While CSU 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Constellation Software
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 CSU
Price-Earnings Ratio = Price per share ÷ Earnings per share
CSU Price-Earnings Ratio = 572.71 ÷ 9.981 = 57.4x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to CSU, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. CSU’s P/E of 57.4x is higher than its industry peers (46.7x), which implies that each dollar of CSU’s earnings is being overvalued by investors. As such, our analysis shows that CSU represents an over-priced stock.
A few caveats
However, before you rush out to sell your CSU shares, 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 CSU, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with CSU, 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 CSU to are fairly valued by the market. If this does not hold true, CSU’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on CSU, 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 you are considering investing in CSU, 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 Constellation Software 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.
