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Should You Be Tempted To Buy Dick’s Sporting Goods Inc (NYSE:DKS) Because Of Its PE Ratio?

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 learn about the link between company’s fundamentals and stock market performance.

Dick’s Sporting Goods Inc (NYSE:DKS) trades with a trailing P/E of 11.6x, which is lower than the industry average of 20.6x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.

View our latest analysis for Dick’s Sporting Goods

Breaking down the Price-Earnings ratio

NYSE:DKS PE PEG Gauge August 27th 18
NYSE:DKS PE PEG Gauge August 27th 18

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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.

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P/E Calculation for DKS

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

DKS Price-Earnings Ratio = $36.02 ÷ $3.107 = 11.6x

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 DKS, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 11.6x, DKS’s P/E is lower than its industry peers (20.6x). This implies that investors are undervaluing each dollar of DKS’s earnings. This multiple is a median of profitable companies of 25 Specialty Retail companies in US including Folli-Follie Commercial Manufacturing and Technical Societe Anonyme, J.Jill and Grand Baoxin Auto Group. Therefore, according to this analysis, DKS is an under-priced stock.

A few caveats

While our conclusion might prompt you to buy DKS immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to DKS. 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 DKS, 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 DKS to are fairly valued by the market. If this does not hold true, DKS’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

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 add more of DKS to your portfolio. 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 highly recommend you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for DKS’s future growth? Take a look at our free research report of analyst consensus for DKS’s outlook.

  2. Past Track Record: Has DKS been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of DKS’s historicals for more clarity.

  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.