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.
S&P Global Inc (NYSE:SPGI) is trading with a trailing P/E of 33.8x, which is higher than the industry average of 16.2x. While SPGI 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.
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for SPGI
Price per share = $210.65
Earnings per share = $6.231
∴ Price-Earnings Ratio = $210.65 ÷ $6.231 = 33.8x
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 SPGI, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
At 33.8x, SPGI’s P/E is higher than its industry peers (16.2x). This implies that investors are overvaluing each dollar of SPGI’s earnings. This multiple is a median of profitable companies of 25 Capital Markets companies in US including Modern Technology, Neon Capital and Oracle Healthcare Acquisition. Therefore, according to this analysis, SPGI is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your SPGI shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to SPGI. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing riskier firms with SPGI, then SPGI’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with SPGI. In this case, SPGI’s P/E would be higher since investors would also reward SPGI’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing SPGI to are fairly valued by the market. If this does not hold, there is a possibility that SPGI’s P/E is higher because firms in our peer group are being undervalued 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 rebalance your portfolio and reduce your holdings in SPGI. 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 SPGI’s future growth? Take a look at our free research report of analyst consensus for SPGI’s outlook.
- Past Track Record: Has SPGI 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 SPGI’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.