I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
The Toro Company (NYSE:TTC) is currently trading at a trailing P/E of 23.9, which is close to the industry average of 23.3. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. 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.
Breaking down 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 TTC
Price-Earnings Ratio = Price per share ÷ Earnings per share
TTC Price-Earnings Ratio = $59.68 ÷ $2.497 = 23.9x
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 TTC, 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. The Toro Company (NYSE:TTC) is trading with a trailing P/E of 23.9, which is close to the industry average of 23.3. This multiple is a median of profitable companies of 25 Machinery companies in US including Eco Energy Tech Asia, Hebron Technology and EnPro Industries. You can think of it like this: the market is suggesting that TTC has similar prospects to its peers in the same industry.
A few caveats
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to TTC. If this isn’t the case, the difference in P/E could be due to other factors. For example, The Toro Company could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with TTC are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
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 rebalance your portfolio and reduce your holdings in TTC. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for TTC’s future growth? Take a look at our free research report of analyst consensus for TTC’s outlook.
- Past Track Record: Has TTC 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 TTC’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 past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.