Does Old Dominion Freight Line Inc's (NASDAQ:ODFL) PE Ratio Warrant A Sell?

This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Old Dominion Freight Line Inc (NASDAQ:ODFL).

Old Dominion Freight Line Inc (NASDAQ:ODFL) trades with a trailing P/E of 23.9x, which is higher than the industry average of 15.3x. While ODFL might seem like a stock to avoid or sell if you own it, 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 to watch out for. View out our latest analysis for Old Dominion Freight Line

Breaking down 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.

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 ODFL, 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.

At 23.9x, ODFL’s P/E is higher than its industry peers (15.3x). This implies that investors are overvaluing each dollar of ODFL’s earnings. This multiple is a median of profitable companies of 25 Transportation companies in US including Aamaxan Transport Group, Earn-A-Car and Ryder System. As such, our analysis shows that ODFL represents an over-priced stock.

Assumptions to be aware of

However, before you rush out to sell your ODFL shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to ODFL. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing riskier firms with ODFL, then ODFL’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with ODFL. In this case, ODFL’s P/E would be higher since investors would also reward ODFL’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing ODFL to are fairly valued by the market. If this does not hold, there is a possibility that ODFL’s P/E is higher because firms in our peer group are being undervalued by the market.

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to ODFL. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 highly recommend you to complete your research by taking a look at the following:

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

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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.