Charter Communications Inc (NASDAQ:CHTR) is currently trading at a trailing P/E of 9.3x, which is lower than the industry average of 17.4x. While this makes CHTR 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Charter Communications
Breaking down the Price-Earnings 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for CHTR
Price per share = $358.02
Earnings per share = $38.544
∴ Price-Earnings Ratio = $358.02 ÷ $38.544 = 9.3x
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 CHTR, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use below. 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.
At 9.3x, CHTR’s P/E is lower than its industry peers (17.4x). This implies that investors are undervaluing each dollar of CHTR’s earnings. Therefore, according to this analysis, CHTR is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy CHTR, 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 CHTR. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing lower risk firms with CHTR, then CHTR’s P/E would naturally be lower than its peers, since investors would value those with lower risk with a higher price. The other possibility is if you were accidentally comparing higher growth firms with CHTR. In this case, CHTR’s P/E would be lower since investors would also reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CHTR to are fairly valued by the market. If this does not hold, there is a possibility that CHTR’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 CHTR, 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 CHTR’s future growth? Take a look at our free research report of analyst consensus for CHTR’s outlook.
- Past Track Record: Has CHTR 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 CHTR’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.