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The Cooper Companies Inc (NYSE:COO) trades with a trailing P/E of 64.8x, which is higher than the industry average of 38.8x. While this makes COO appear like a stock to avoid or sell if you own it, 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 Cooper Companies
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in 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 COO
Price-Earnings Ratio = Price per share ÷ Earnings per share
COO Price-Earnings Ratio = $231.42 ÷ $3.569 = 64.8x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to COO, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 64.8x, COO’s P/E is higher than its industry peers (38.8x). This implies that investors are overvaluing each dollar of COO’s earnings. As such, our analysis shows that COO represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your COO shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to COO. 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 COO, 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 COO to are fairly valued by the market. If this is violated, COO’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in COO. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 urge you to complete your research by taking a look at the following: