What Does American Vanguard Corporation's (NYSE:AVD) PE Ratio Tell You?

This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

American Vanguard Corporation (NYSE:AVD) trades on a trailing P/E of 20.8. This isn't too far from the industry average (which is 20.4). While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what other factors to keep in mind.

Check out our latest analysis for American Vanguard

What you need to know about the P/E 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.

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 AVD, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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.

American Vanguard Corporation (NYSE:AVD) trades on a trailing P/E of 20.8. This isn't too far from the industry average (which is 20.4). This multiple is a median of profitable companies of 25 Chemicals companies in US including Nocopi Technologies, Rayonier Advanced Materials and Venator Materials. One could put it like this: the market is pricing AVD as if it is roughly average for its industry.

Assumptions to be aware of

Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to AVD. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where American Vanguard Corporation is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to AVD may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.

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 AVD. 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 urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for AVD’s future growth? Take a look at our free research report of analyst consensus for AVD’s outlook.
2. Past Track Record: Has AVD 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 AVD'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.