Should You Sell Echelon Financial Holdings Inc (TSE:EFH) At This PE Ratio?

This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Echelon Financial Holdings Inc (TSE:EFH).

Echelon Financial Holdings Inc (TSE:EFH) is currently trading at a trailing P/E of 29.3x, which is higher than the industry average of 14.4x. While EFH 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. See our latest analysis for Echelon Financial Holdings

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.

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 EFH, 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.

EFH’s P/E of 29.3x is higher than its industry peers (14.4x), which implies that each dollar of EFH’s earnings is being overvalued by investors. Therefore, according to this analysis, EFH is an over-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to sell your EFH shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to EFH. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared riskier firms with EFH, then investors would naturally value EFH at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with EFH, investors would also value EFH at a higher price since it is a higher growth investment. Both scenarios would explain why EFH has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing EFH to are fairly valued by the market. If this assumption does not hold true, EFH’s higher P/E ratio may be 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 EFH. 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 urge you to complete your research by taking a look at the following:

1. Financial Health: Is EFH’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 EFH 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 EFH'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

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.