This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Enova International Inc (NYSE:ENVA) trades with a trailing P/E of 16.8, which is higher than the industry average of 12.1. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Breaking down the Price-Earnings 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for ENVA
Price per share = $24.72
Earnings per share = $1.473
∴ Price-Earnings Ratio = $24.72 ÷ $1.473 = 16.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to ENVA, such as capital structure and profitability. 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.
Since ENVA’s P/E of 16.8 is higher than its industry peers (12.1), it means that investors are paying more for each dollar of ENVA’s earnings. This multiple is a median of profitable companies of 22 Consumer Finance companies in US including Qudian, Hexindai and Santander Consumer USA Holdings. You could think of it like this: the market is pricing ENVA as if it is a stronger company than the average of its industry group.
Assumptions to watch out for
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to ENVA. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Enova International Inc is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with ENVA are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
Since you may have already conducted your due diligence on ENVA, the overvaluation of the stock may mean it is a good time to reduce 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for ENVA’s future growth? Take a look at our free research report of analyst consensus for ENVA’s outlook.
- Past Track Record: Has ENVA 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 ENVA’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 firstname.lastname@example.org.