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.
Cross Country Healthcare Inc (NASDAQ:CCRN) is currently trading at a trailing P/E of 7.8, which is lower than the industry average of 22. Although some investors might think this is a real positive, that might change once you understand the assumptions behind the P/E. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
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 CCRN
Price per share = $8.21
Earnings per share = $1.059
∴ Price-Earnings Ratio = $8.21 ÷ $1.059 = 7.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 CCRN, 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.
CCRN’s P/E of 7.8 is lower than its industry peers (22), which implies that each dollar of CCRN’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Healthcare companies in US including Quantum Medical Transport, U.S. NeuroSurgical Holdings and JRSIS Health Care. You can think of it like this: the market is suggesting that CCRN is a weaker business than the average comparable company.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to CCRN. 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 CCRN, then investors would naturally value CCRN at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with CCRN, investors would also value CCRN at a lower price since it is a lower growth investment. Both scenarios would explain why CCRN has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing CCRN to are fairly valued by the market. If this does not hold, there is a possibility that CCRN’s P/E is lower because firms in our peer group are being overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on CCRN, 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for CCRN’s future growth? Take a look at our free research report of analyst consensus for CCRN’s outlook.
- Past Track Record: Has CCRN 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 CCRN’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.