Yahoo Finance Should You Be Tempted To Buy Sonic Automotive Inc (NYSE:SAH) At Its Current PE Ratio?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Sonic Automotive Inc (NYSE:SAH) is currently trading at a trailing P/E of 8.6x, which is lower than the industry average of 21.2x. While this makes SAH 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.
View our latest analysis for Sonic Automotive
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 SAH
Price-Earnings Ratio = Price per share ÷ Earnings per share
SAH Price-Earnings Ratio = $19.4 ÷ $2.252 = 8.6x
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 SAH, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. SAH’s P/E of 8.6 is lower than its industry peers (21.2), which implies that each dollar of SAH’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Specialty Retail companies in US including Folli-Follie Commercial Manufacturing and Technical Societe Anonyme, J.Jill and Bed Bath & Beyond. One could put it like this: the market is pricing SAH as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to SAH, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with SAH, 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 SAH to are fairly valued by the market. If this does not hold true, SAH’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 SAH, 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for SAH’s future growth? Take a look at our free research report of analyst consensus for SAH’s outlook.
Past Track Record: Has SAH 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 SAH’s historicals for more clarity.
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.
