Does Currency Exchange International Corp's (TSE:CXI) PE Ratio Signal A Selling Opportunity?

Currency Exchange International Corp (TSX:CXI) is currently trading at a trailing P/E of 30.4x, which is higher than the industry average of 18.4x. 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. See our latest analysis for Currency Exchange International

Breaking down the P/E ratio

P/E is often used for relative valuation since earnings power is a chief 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.

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to CXI, 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.

Since CXI's P/E of 30.4x is higher than its industry peers (18.4x), it means that investors are paying more than they should for each dollar of CXI's earnings. Therefore, according to this analysis, CXI is an over-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to sell your CXI 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 CXI. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with CXI, then investors would naturally value CXI at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with CXI, investors would also value CXI at a higher price since it is a higher growth investment. Both scenarios would explain why CXI has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing CXI to are fairly valued by the market. If this assumption does not hold true, CXI’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 CXI. 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 urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for CXI’s future growth? Take a look at our free research report of analyst consensus for CXI’s outlook.
2. Past Track Record: Has CXI 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 CXI'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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.