Does Gardner Denver Holdings Inc's (NYSE:GDI) PE Ratio Warrant A Sell?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Gardner Denver Holdings Inc (NYSE:GDI)’s fundamentals and stock market performance.

Gardner Denver Holdings Inc (NYSE:GDI) is trading with a trailing P/E of 86.5x, which is higher than the industry average of 22.9x. While GDI 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. Check out our latest analysis for Gardner Denver Holdings

Demystifying the P/E ratio

The P/E ratio is one of many ratios used in 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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as GDI, 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.

Since GDI's P/E of 86.5x is higher than its industry peers (22.9x), it means that investors are paying more than they should for each dollar of GDI's earnings. Therefore, according to this analysis, GDI is an over-priced stock.

Assumptions to be aware of

Before you jump to the conclusion that GDI should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to GDI. 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 GDI, then investors would naturally value GDI at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with GDI, investors would also value GDI at a higher price since it is a higher growth investment. Both scenarios would explain why GDI has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing GDI to are fairly valued by the market. If this assumption is violated, GDI's P/E may be higher than its peers because its peers are actually undervalued by investors.

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to GDI. 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 urge you to complete your research by taking a look at the following:

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

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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.