MSA Safety Incorporated (NYSE:MSA) is currently trading at a trailing P/E of 75.7x, which is higher than the industry average of 17.6x. While MSA 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for MSA Safety

Demystifying the P/E ratio

The P/E ratio is one of many ratios used in 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 MSA

Price-Earnings Ratio = Price per share ÷ Earnings per share

MSA Price-Earnings Ratio = $87.15 ÷ $1.151 = 75.7x

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 MSA, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. MSA’s P/E of 75.7x is higher than its industry peers (17.6x), which implies that each dollar of MSA’s earnings is being overvalued by investors. Therefore, according to this analysis, MSA is an over-priced stock.

A few caveats

Before you jump to the conclusion that MSA should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to MSA. 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 MSA, 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 MSA to are fairly valued by the market. If this does not hold true, MSA’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

What this means for you:

Since you may have already conducted your due diligence on MSA, 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. 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: