In This Article:
City Service SE (WSE:CTS) trades with a trailing P/E of 13.2x, which is lower than the industry average of 13.3x. While this makes CTS appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 City Service
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 CTS
Price-Earnings Ratio = Price per share ÷ Earnings per share
CTS Price-Earnings Ratio = €2.56 ÷ €0.195 = 13.2x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 CTS, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since CTS’s P/E of 13.2x is lower than its industry peers (13.3x), it means that investors are paying less than they should for each dollar of CTS’s earnings. As such, our analysis shows that CTS represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy CTS immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to CTS. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with CTS, 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 CTS to are fairly valued by the market. If this does not hold, there is a possibility that CTS’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 CTS, 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 highly recommend you to complete your research by taking a look at the following: