BRP Inc (TSX:DOO) is trading with a trailing P/E of 20.9x, which is lower than the industry average of 22.4x. While DOO might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for BRP
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.
P/E Calculation for DOO
Price-Earnings Ratio = Price per share ÷ Earnings per share
DOO Price-Earnings Ratio = CA$53.47 ÷ CA$2.564 = 20.9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to DOO, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. DOO’s P/E of 20.9x is lower than its industry peers (22.4x), which implies that each dollar of DOO’s earnings is being undervalued by investors. Therefore, according to this analysis, DOO is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy DOO immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to DOO, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with DOO, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing DOO to are fairly valued by the market. If this is violated, DOO’s P/E may be lower than its peers as they are actually overvalued by investors.
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 DOO 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: