Town Sports International Holdings Inc (NASDAQ:CLUB) is currently trading at a trailing P/E of 51.3x, which is higher than the industry average of 21.6x. While this makes CLUB 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. 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 Town Sports International Holdings
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 CLUB
Price-Earnings Ratio = Price per share ÷ Earnings per share
CLUB Price-Earnings Ratio = $8.4 ÷ $0.164 = 51.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to CLUB, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since CLUB’s P/E of 51.3x is higher than its industry peers (21.6x), it means that investors are paying more than they should for each dollar of CLUB’s earnings. Therefore, according to this analysis, CLUB is an over-priced stock.
A few caveats
However, before you rush out to sell your CLUB 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 CLUB. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with CLUB, 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 CLUB to are fairly valued by the market. If this does not hold true, CLUB’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
To help readers see pass 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.