Vince Holding Corp (NYSE:VNCE) trades with a trailing P/E of 1.6x, which is lower than the industry average of 24.9x. While this makes VNCE appear like a great stock to buy, 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. Check out our latest analysis for Vince Holding
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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for VNCE
Price per share = $12.1
Earnings per share = $7.704
∴ Price-Earnings Ratio = $12.1 ÷ $7.704 = 1.6x
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 VNCE, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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 1.6x, VNCE’s P/E is lower than its industry peers (24.9x). This implies that investors are undervaluing each dollar of VNCE’s earnings. Therefore, according to this analysis, VNCE is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy VNCE, 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 VNCE. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with VNCE, then investors would naturally value VNCE at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with VNCE, investors would also value VNCE at a lower price since it is a lower growth investment. Both scenarios would explain why VNCE has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing VNCE to are fairly valued by the market. If this assumption is violated, VNCE’s P/E may be lower than its peers because its peers are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on VNCE, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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:
- Financial Health: Is VNCE’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.
- Past Track Record: Has VNCE 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 VNCE’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.