This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Victory Capital Holdings Inc (NASDAQ:VCTR) trades with a trailing P/E of 11x, which is lower than the industry average of 24.1x. 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.
Demystifying 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 VCTR
Price-Earnings Ratio = Price per share ÷ Earnings per share
VCTR Price-Earnings Ratio = $8.89 ÷ $0.805 = 11x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as VCTR, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since VCTR’s P/E of 11 is lower than its industry peers (24.1), it means that investors are paying less for each dollar of VCTR’s earnings. This multiple is a median of profitable companies of 24 Capital Markets companies in US including Neon Capital, Hallmark Venture Group and Viking Energy Group. One could put it like this: the market is pricing VCTR as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to VCTR. 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 VCTR, 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 VCTR to are fairly valued by the market. If this does not hold, there is a possibility that VCTR’s P/E is lower because our peer group is overvalued by the market.
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 add more of VCTR to your portfolio. 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 VCTR’s future growth? Take a look at our free research report of analyst consensus for VCTR’s outlook.
- Financial Health: Are VCTR’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- 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.