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.
Daseke Inc (NASDAQ:DSKE) is trading with a trailing P/E of 9.5x, which is lower than the industry average of 15.4x. While this makes DSKE 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.
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 DSKE
Price per share = $8.79
Earnings per share = $0.922
∴ Price-Earnings Ratio = $8.79 ÷ $0.922 = 9.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as DSKE, 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.
At 9.5x, DSKE’s P/E is lower than its industry peers (15.4x). This implies that investors are undervaluing each dollar of DSKE’s earnings. This multiple is a median of profitable companies of 24 Transportation companies in US including Aamaxan Transport Group, Ryder System and Go-Ahead Group. Therefore, according to this analysis, DSKE is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy DSKE immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to DSKE. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with DSKE, then DSKE’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with DSKE, DSKE’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing DSKE to are fairly valued by the market. If this does not hold, there is a possibility that DSKE’s P/E is lower because firms in our peer group are being overvalued by the market.
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 add more of DSKE to your portfolio. 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:
- Future Outlook: What are well-informed industry analysts predicting for DSKE’s future growth? Take a look at our free research report of analyst consensus for DSKE’s outlook.
- Financial Health: Are DSKE’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- 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.