I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
The Greenbrier Companies Inc (NYSE:GBX) trades with a trailing P/E of 12.5x, which is lower than the industry average of 20.9x. While GBX might seem like an attractive stock to buy, 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 a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 GBX
Price-Earnings Ratio = Price per share ÷ Earnings per share
GBX Price-Earnings Ratio = $60 ÷ $4.817 = 12.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to GBX, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since GBX’s P/E of 12.5 is lower than its industry peers (20.9), it means that investors are paying less for each dollar of GBX’s earnings. This multiple is a median of profitable companies of 24 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 GBX is a weaker business than the average comparable company.
A few caveats
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to GBX, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with GBX, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing GBX to are fairly valued by the market. If this is violated, GBX’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on GBX, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 GBX’s future growth? Take a look at our free research report of analyst consensus for GBX’s outlook.
- Past Track Record: Has GBX 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 GBX’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.