What Does BMC Stock Holdings Inc's (NASDAQ:BMCH) PE Ratio Tell You?

This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.

BMC Stock Holdings Inc (NASDAQ:BMCH) is currently trading at a trailing P/E of 16.6x, which is higher than the industry average of 13.7x. While this makes BMCH 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. Today, 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 BMC Stock Holdings

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.

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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to BMCH, 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 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.

At 16.6x, BMCH’s P/E is higher than its industry peers (13.7x). This implies that investors are overvaluing each dollar of BMCH’s earnings. This multiple is a median of profitable companies of 25 Trade Distributors companies in US including Star Struck, Spicers and APAC Resources. As such, our analysis shows that BMCH represents an over-priced stock.

Assumptions to be aware of

However, before you rush out to sell your BMCH 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 BMCH. 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 BMCH, then investors would naturally value BMCH at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with BMCH, investors would also value BMCH at a higher price since it is a higher growth investment. Both scenarios would explain why BMCH has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing BMCH to are fairly valued by the market. If this assumption is violated, BMCH's P/E may be higher than its peers because its peers are actually undervalued by investors.

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

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 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.