CBG Capital Limited (ASX:CBC) trades with a trailing P/E of 23.3x, which is higher than the industry average of 22.2x. While this makes CBC appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for CBG Capital
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 CBC
Price-Earnings Ratio = Price per share ÷ Earnings per share
CBC Price-Earnings Ratio = A$0.88 ÷ A$0.038 = 23.3x
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 CBC, 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. At 23.3x, CBC’s P/E is higher than its industry peers (22.2x). This implies that investors are overvaluing each dollar of CBC’s earnings. Therefore, according to this analysis, CBC is an over-priced stock.
A few caveats
However, before you rush out to sell your CBC shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CBC. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with CBC, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CBC to are fairly valued by the market. If this does not hold true, CBC’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in CBC. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If CBC has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.