This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between ThreeD Capital Inc (CNSX:IDK)’s fundamentals and stock market performance.
ThreeD Capital Inc (CNSX:IDK) is trading with a trailing P/E of 2.1x, which is lower than the industry average of 12.4x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for ThreeD Capital
What you need to know about the P/E 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for IDK
Price per share = CA$0.14
Earnings per share = CA$0.0656
∴ Price-Earnings Ratio = CA$0.14 ÷ CA$0.0656 = 2.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as IDK, such as size and country of operation. 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.
Since IDK’s P/E of 2.1x is lower than its industry peers (12.4x), it means that investors are paying less than they should for each dollar of IDK’s earnings. Therefore, according to this analysis, IDK is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy IDK 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 IDK. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with IDK, then investors would naturally value IDK at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with IDK, investors would also value IDK at a lower price since it is a lower growth investment. Both scenarios would explain why IDK has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing IDK to are fairly valued by the market. If this does not hold, there is a possibility that IDK’s P/E is lower because firms in our peer group are being overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on IDK, 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 highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is IDK’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.
- Past Track Record: Has IDK 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 IDK’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.