Should You Be Tempted To Buy H&R Block Inc (NYSE:HRB) At Its Current PE Ratio?

This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

H&R Block Inc (NYSE:HRB) is currently trading at a trailing P/E of 8.8x, which is lower than the industry average of 24.8x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.

Check out our latest analysis for H&R Block

What you need to know about the P/E ratio

P/E is a popular ratio used for relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 HRB, 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.

Since HRB's P/E of 8.8x is lower than its industry peers (24.8x), it means that investors are paying less than they should for each dollar of HRB's earnings. This multiple is a median of profitable companies of 24 Consumer Services companies in US including Kid Castle Educational, China Education Resources and CIBT Education Group. Therefore, according to this analysis, HRB is an under-priced stock.

A few caveats

Before you jump to the conclusion that HRB represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to HRB. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with HRB, then investors would naturally value HRB at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with HRB, investors would also value HRB at a lower price since it is a lower growth investment. Both scenarios would explain why HRB has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing HRB to are fairly valued by the market. If this assumption is violated, HRB's P/E may be lower than its peers because its peers are actually overvalued by investors.

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to HRB. 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 HRB’s future growth? Take a look at our free research report of analyst consensus for HRB’s outlook.
2. Past Track Record: Has HRB 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 HRB'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.