In This Article:
This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.
Deere & Company (NYSE:DE) is trading with a trailing P/E of 23.6, which is close to the industry average of 23.6. Although some investors may jump to the conclusion that this is a great buying opportunity, 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.
View our latest analysis for Deere
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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.
P/E Calculation for DE
Price-Earnings Ratio = Price per share ÷ Earnings per share
DE Price-Earnings Ratio = $152.81 ÷ $6.482 = 23.6x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as DE, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Deere & Company (NYSE:DE) is trading with a trailing P/E of 23.6, which is close to the industry average of 23.6. This multiple is a median of profitable companies of 25 Machinery companies in US including Philly Shipyard, EnPro Industries and Eco Energy Tech Asia. One could put it like this: the market is pricing DE as if it is roughly average for its industry.
Assumptions to be aware of
However, 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 DE, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with DE, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing DE to are fairly valued by the market. If this does not hold, there is a possibility that DE’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on DE, the undervaluation of the stock may mean it is a good time to top up on 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 urge you to complete your research by taking a look at the following: