Valmont Industries Inc (NYSE:VMI) trades with a trailing P/E of 27.8x, which is higher than the industry average of 16.2x. While this makes VMI 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Valmont Industries
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 VMI
Price per share = $143.4
Earnings per share = $5.162
∴ Price-Earnings Ratio = $143.4 ÷ $5.162 = 27.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to VMI, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. 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 27.8x, VMI’s P/E is higher than its industry peers (16.2x). This implies that investors are overvaluing each dollar of VMI’s earnings. Therefore, according to this analysis, VMI is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your VMI shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to VMI. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with VMI, then investors would naturally value VMI at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with VMI, investors would also value VMI at a higher price since it is a higher growth investment. Both scenarios would explain why VMI has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing VMI to are fairly valued by the market. If this does not hold, there is a possibility that VMI’s P/E is higher because firms in our peer group are being undervalued by the market.
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 VMI. 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:
- Future Outlook: What are well-informed industry analysts predicting for VMI’s future growth? Take a look at our free research report of analyst consensus for VMI’s outlook.
- Past Track Record: Has VMI 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 VMI'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.
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Simply Wall St has no position in any of the companies mentioned. This article is general in nature. 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.
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