Shoe Carnival Inc (NASDAQ:SCVL) is currently trading at a trailing P/E of 20.5x, which is higher than the industry average of 18x. While SCVL 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 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 Shoe Carnival
What you need to know about 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 SCVL
Price-Earnings Ratio = Price per share ÷ Earnings per share
SCVL Price-Earnings Ratio = $26.75 ÷ $1.304 = 20.5x
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. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SCVL, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 20.5x, SCVL’s P/E is higher than its industry peers (18x). This implies that investors are overvaluing each dollar of SCVL’s earnings. Therefore, according to this analysis, SCVL is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your SCVL 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 SCVL. 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 SCVL, 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 SCVL to are fairly valued by the market. If this is violated, SCVL’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? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to SCVL. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If SCVL 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 Shoe Carnival 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.