In This Article:
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Sun Life Financial Inc (TSE:SLF) is trading with a trailing P/E of 12.6, which is higher than the industry average of 11.7. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. Today, 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 Sun Life Financial
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. 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 SLF
Price-Earnings Ratio = Price per share ÷ Earnings per share
SLF Price-Earnings Ratio = CA$49.34 ÷ CA$3.93 = 12.6x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SLF, 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. Since SLF’s P/E of 12.6 is higher than its industry peers (11.7), it means that investors are paying more for each dollar of SLF’s earnings. This multiple is a median of profitable companies of 10 Insurance companies in CA including Fairfax Financial Holdings, E-L Financial and Power of Canada. You could also say that the market is suggesting that SLF is a stronger business than the average comparable company.
A few caveats
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to SLF. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where Sun Life Financial Inc is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to SLF may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to SLF. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 highly recommend you to complete your research by taking a look at the following: