This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Corporación América Airports SA (NYSE:CAAP) trades with a trailing P/E of 25.6x, which is higher than the industry average of 17.5x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down the P/E ratio
P/E is a popular ratio used for 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for CAAP
Price per share = $9.84
Earnings per share = $0.384
∴ Price-Earnings Ratio = $9.84 ÷ $0.384 = 25.6x
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 CAAP, such as size and country of operation. 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.
Since CAAP’s P/E of 25.6x is higher than its industry peers (17.5x), it means that investors are paying more than they should for each dollar of CAAP’s earnings. This multiple is a median of profitable companies of 25 Infrastructure companies in US including COSCO SHIPPING Ports, COSCO SHIPPING Ports and OHL México. de. Therefore, according to this analysis, CAAP is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that CAAP should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to CAAP. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with CAAP, then CAAP’s P/E would naturally be higher since investors would reward CAAP’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with CAAP, CAAP’s P/E would again be higher since investors would reward CAAP’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing CAAP to are fairly valued by the market. If this assumption does not hold true, CAAP’s higher P/E ratio may be because firms in our peer group are being undervalued by the market.
What this means for you:
Since you may have already conducted your due diligence on CAAP, the overvaluation of the stock may mean it is a good time to reduce 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for CAAP’s future growth? Take a look at our free research report of analyst consensus for CAAP’s outlook.
- Financial Health: Are CAAP’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.