This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Robert Half International Inc (NYSE:RHI) is currently trading at a trailing P/E of 28.1x, which is higher than the industry average of 25.5x. While RHI 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 explain what the P/E ratio is as well as what you should look out for when using it.
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 RHI
Price per share = $77.5
Earnings per share = $2.755
∴ Price-Earnings Ratio = $77.5 ÷ $2.755 = 28.1x
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 RHI, 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.
RHI’s P/E of 28.1x is higher than its industry peers (25.5x), which implies that each dollar of RHI’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Professional Services companies in US including ADGS Advisory, Volt Information Sciences and Impellam Group. As such, our analysis shows that RHI represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your RHI shares, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to RHI. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with RHI, then RHI’s P/E would naturally be higher since investors would reward RHI’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with RHI, RHI’s P/E would again be higher since investors would reward RHI’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing RHI to are fairly valued by the market. If this assumption does not hold true, RHI’s higher P/E ratio may be 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 RHI. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for RHI’s future growth? Take a look at our free research report of analyst consensus for RHI’s outlook.
- Past Track Record: Has RHI 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 RHI’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.
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 email@example.com.