This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Ford Motor Company (NYSE:F)’s fundamentals and stock market performance.
Ford Motor Company (NYSE:F) is currently trading at a trailing P/E of 5.6x, which is lower than the industry average of 9.2x. While this makes F appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. View out our latest analysis for Ford Motor
What you need to know about 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for F
Price per share = $10.99
Earnings per share = $1.949
∴ Price-Earnings Ratio = $10.99 ÷ $1.949 = 5.6x
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 F, such as size and country of operation. 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.
At 5.6x, F’s P/E is lower than its industry peers (9.2x). This implies that investors are undervaluing each dollar of F’s earnings. This multiple is a median of profitable companies of 24 Auto companies in US including New Dover Capital, Renault and Renault. Therefore, according to this analysis, F is an under-priced stock.
A few caveats
Before you jump to the conclusion that F represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to F. 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 F, then investors would naturally value F at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with F, investors would also value F at a lower price since it is a lower growth investment. Both scenarios would explain why F has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing F to are fairly valued by the market. If this assumption is violated, F’s P/E may be lower than its peers because its peers are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to F. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for F’s future growth? Take a look at our free research report of analyst consensus for F’s outlook.
- Past Track Record: Has F 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 F’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.