This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.
Cortex Business Solutions Inc (CVE:CBX) is trading with a trailing P/E of 30.3x, which is lower than the industry average of 30.5x. 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Breaking down 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 CBX
Price per share = CA$3.7
Earnings per share = CA$0.122
∴ Price-Earnings Ratio = CA$3.7 ÷ CA$0.122 = 30.3x
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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CBX, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use below. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
Since CBX’s P/E of 30.3x is lower than its industry peers (30.5x), it means that investors are paying less than they should for each dollar of CBX’s earnings. This multiple is a median of profitable companies of 7 Internet companies in CA including Armada Data, Mediagrif Interactive Technologies and Tucows. As such, our analysis shows that CBX represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy CBX, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to CBX. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared higher growth firms with CBX, then CBX’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with CBX, CBX’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing CBX to are fairly valued by the market. If this assumption does not hold true, CBX’s lower P/E ratio may be 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 CBX, 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:
- Future Outlook: What are well-informed industry analysts predicting for CBX’s future growth? Take a look at our free research report of analyst consensus for CBX’s outlook.
- Past Track Record: Has CBX 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 CBX’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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.