Buhler Industries Inc (TSX:BUI) trades with a trailing P/E of 85.9x, which is higher than the industry average of 23.7x. While BUI 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Buhler Industries
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for BUI
Price per share = CA$4.6
Earnings per share = CA$0.054
∴ Price-Earnings Ratio = CA$4.6 ÷ CA$0.054 = 85.9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to BUI, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
Since BUI’s P/E of 85.9x is higher than its industry peers (23.7x), it means that investors are paying more than they should for each dollar of BUI’s earnings. As such, our analysis shows that BUI represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your BUI shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to BUI. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with BUI, then BUI’s P/E would naturally be higher since investors would reward BUI’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with BUI, BUI’s P/E would again be higher since investors would reward BUI’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing BUI to are fairly valued by the market. If this does not hold, there is a possibility that BUI’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 BUI. 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 highly recommend you to complete your research by taking a look at the following:
1. Financial Health: Is BUI’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.
2. Past Track Record: Has BUI 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 BUI’s historicals for more clarity.
3. 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.