IES Holdings Inc (NASDAQ:IESC) trades with a trailing P/E of 27.3x, which is higher than the industry average of 19.5x. While IESC might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 IES Holdings
What you need to know about the P/E 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 IESC
Price-Earnings Ratio = Price per share ÷ Earnings per share
IESC Price-Earnings Ratio = $17.05 ÷ $0.624 = 27.3x
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 IESC, 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. IESC’s P/E of 27.3x is higher than its industry peers (19.5x), which implies that each dollar of IESC’s earnings is being overvalued by investors. Therefore, according to this analysis, IESC is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that IESC should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to IESC, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with IESC, 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 IESC to are fairly valued by the market. If this does not hold true, IESC’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? Since you may have already conducted your due diligence on IESC, the overvaluation of the stock may mean it is a good time to reduce 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.