ASV Holdings Inc (NASDAQ:ASV) is currently trading at a trailing P/E of 40.3x, which is higher than the industry average of 23.1x. While this makes ASV appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for ASV Holdings
Demystifying 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 ASV
Price per share = $7.54
Earnings per share = $0.187
∴ Price-Earnings Ratio = $7.54 ÷ $0.187 = 40.3x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 ASV, 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.
At 40.3x, ASV’s P/E is higher than its industry peers (23.1x). This implies that investors are overvaluing each dollar of ASV’s earnings. Therefore, according to this analysis, ASV is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your ASV shares, 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 ASV. 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 ASV, then investors would naturally value ASV at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with ASV, investors would also value ASV at a higher price since it is a higher growth investment. Both scenarios would explain why ASV has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing ASV to are fairly valued by the market. If this does not hold, there is a possibility that ASV’s P/E is higher 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 ASV. 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:
- Future Outlook: What are well-informed industry analysts predicting for ASV’s future growth? Take a look at our free research report of analyst consensus for ASV’s outlook.
- Financial Health: Is ASV’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.
- 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.