This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
World Wrestling Entertainment Inc (NYSE:WWE) is currently trading at a trailing P/E of 85.4, which is higher than the industry average of 19.5. While this might not seem positive, 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.
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 WWE
Price-Earnings Ratio = Price per share ÷ Earnings per share
WWE Price-Earnings Ratio = $69.78 ÷ $0.817 = 85.4x
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 WWE, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since WWE’s P/E of 85.4 is higher than its industry peers (19.5), it means that investors are paying more for each dollar of WWE’s earnings. This multiple is a median of profitable companies of 23 Entertainment companies in US including Dolphin Entertainment, Chicken Soup for the Soul Entertainment and Viacom. You could think of it like this: the market is pricing WWE as if it is a stronger company than the average of its industry group.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to WWE. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where World Wrestling Entertainment Inc is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with WWE are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
What this means for you:
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 WWE. 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. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for WWE’s future growth? Take a look at our free research report of analyst consensus for WWE’s outlook.
- Past Track Record: Has WWE 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 WWE’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.