The Cheesecake Factory Incorporated (NASDAQ:CAKE) is trading with a trailing P/E of 14.4x, which is lower than the industry average of 21.6x. While this makes CAKE 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 Cheesecake Factory
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for 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.
Formula
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for CAKE
Price per share = $48.22
Earnings per share = $3.354
∴ Price-Earnings Ratio = $48.22 ÷ $3.354 = 14.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to CAKE, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
CAKE’s P/E of 14.4x is lower than its industry peers (21.6x), which implies that each dollar of CAKE’s earnings is being undervalued by investors. As such, our analysis shows that CAKE represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy CAKE, 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 CAKE. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing lower risk firms with CAKE, then CAKE’s P/E would naturally be lower than its peers, since investors would value those with lower risk with a higher price. The other possibility is if you were accidentally comparing higher growth firms with CAKE. In this case, CAKE’s P/E would be lower since investors would also reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CAKE to are fairly valued by the market. If this does not hold, there is a possibility that CAKE’s P/E is lower because firms in our peer group are being 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 CAKE 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:
- Future Outlook: What are well-informed industry analysts predicting for CAKE’s future growth? Take a look at our free research report of analyst consensus for CAKE’s outlook.
- Past Track Record: Has CAKE 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 CAKE’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.
TOP undervalued stocks for 2017
Looking for undervalued stocks? The trick is not to follow the herd. These overlooked companies are now trading for less than their intrinsic value. Click here to see them for FREE on the Simply Wall St platform.Bagikan Berita Ini
0 Response to "Does The Cheesecake Factory Incorporated's (NASDAQ:CAKE) PE Ratio Signal A Buying Opportunity?"
Post a Comment