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Diamond Hill Investment Group Inc (NASDAQ:DHIL) is currently trading at a trailing P/E of 13.9x, which is lower than the industry average of 15.8x. While this makes DHIL appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Diamond Hill Investment Group
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 DHIL
Price-Earnings Ratio = Price per share ÷ Earnings per share
DHIL Price-Earnings Ratio = $201.75 ÷ $14.494 = 13.9x
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 DHIL, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 13.9x, DHIL’s P/E is lower than its industry peers (15.8x). This implies that investors are undervaluing each dollar of DHIL’s earnings. Therefore, according to this analysis, DHIL is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy DHIL immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to DHIL, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with DHIL, 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 DHIL to are fairly valued by the market. If this does not hold true, DHIL’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.