Fleetwood Corporation Limited (ASX:FWD) is trading with a trailing P/E of 31.7x, which is higher than the industry average of 13.2x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Fleetwood
Demystifying the P/E ratio
P/E is a popular ratio used for 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 FWD
Price per share = A$2.55
Earnings per share = A$0.081
∴ Price-Earnings Ratio = A$2.55 ÷ A$0.081 = 31.7x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to FWD, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use below. 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 31.7x, FWD’s P/E is higher than its industry peers (13.2x). This implies that investors are overvaluing each dollar of FWD’s earnings. As such, our analysis shows that FWD represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that FWD should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to FWD. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with FWD, then FWD’s P/E would naturally be higher since investors would reward FWD’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with FWD, FWD’s P/E would again be higher since investors would reward FWD’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing FWD to are fairly valued by the market. If this assumption does not hold true, FWD’s higher P/E ratio may be because firms in our peer group are being undervalued by the market.
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 FWD. 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 FWD’s future growth? Take a look at our free research report of analyst consensus for FWD’s outlook.
- Past Track Record: Has FWD 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 FWD’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.