Citizens Financial Group Inc (NYSE: CFG) shares currently trade at 12.4x trailing earnings which is lower than the Financials sector median of 18.9x. While this makes CFG look like a stock to add to your portfolio, equity investors might change their mind after taking a closer look at the assumptions behind the P/E ratio. In this article, I define how to calculate a P/E multiple and what to keep an eye out for when applying it in a comparable companies analysis.
Citizens Financial Comparable Companies Analysis
A comparable companies analysis, also known as a multiples valuation, determines the value of a subject company by benchmarking its financial performance against similar public companies or peers. We can conclude if a company looks undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation ratios.
A P/E Ratio is a valuation metric that indicates the multiple of earnings investors are willing to pay for one share of a company:
P/E Ratio = Stock Price ÷ Earnings Per Share
The P/E ratio by itself is not very helpful at all. It is only useful when comparing it to other companies that are considered similar to the subject company. The basic idea is that companies with similar characteristics should trade at similar multiples, all other things being equal. Therefore, we can come to a conclusion about the stock if the ratios are different. In the chart below, I compare Citizens Financial’s P/E ratio to its peer group that includes M&T Bank Corporation (NYSE: MTB), KeyCorp (NYSE: KEY), Regions Financial Corporation (NYSE: RF) and SunTrust Banks, Inc. (NYSE: STI).
Since Citizens Financial’s P/E of 12.4x is lower than the median of its peers (16.8x), it means that investors are paying less than they should for each dollar of CFG’s earnings. As such, our analysis shows that CFG represents an undervalued stock. In fact, finbox.io’s P/E Multiple Model calculates a fair value of $55.32 per share which implies 29.5% upside.
I selected a fair multiple of 16.1x in my analysis by averaging Citizens Financial’s current P/E ratio with its peer group and sector.
Are Peers Really Comparable?
Before concluding that Citizens Financial should be added to your portfolio, it is important to understand that our conclusion rests on two important assumptions.
(1) the selected peer group actually contains companies that truly are similar to Citizens Financial, and
(2) the selected peer group stocks are being fairly valued by the market.
If the first assumption is not accurate, the difference in P/E ratios could be due to a variety of factors. For example, if you accidentally compare Citizens Financial with higher growth companies, then its P/E multiple would naturally be lower than its peers since investors reward high growth stocks with a higher price.
source: P/E model
However, if the second assumption does not hold true, Citizens Financial’s lower multiple may be because firms in our peer group are being overvalued by the market.
How This Impacts Shareholders
As a shareholder, you may have already conducted fundamental analysis on the stock so its current undervaluation could signal a potential buying opportunity to increase your position in CFG. However, keep in mind the limitations of the P/E ratio when making investment decisions. There are a variety of other fundamental factors that I have not taken into consideration in this article. If you have not done so already, I highly recommend that you complete your research on Citizens Financial by taking a look at the following:
Valuation Metrics: how much upside do shares of Citizens Financial have based on the Ben Graham Formula? Take a look at our Ben Graham Formula data explorer which also compares the company’s upside to its peers.
Risk Metrics: what is Citizens Financial’s Altman Z score? It’s a famous formula used to predict the probability that a firm will go into bankruptcy within two years. View the company’s Altman Z score here.
Efficiency Metrics: how much free cash flow does Citizens Financial generate as a percentage of total sales? Has it been increasing or decreasing over time? Review the firm’s free cash flow margin here.
Author: Andy Pai
Expertise: financial modeling, mergers & acquisitions
Andy is also a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to do investment research. Andy’s background is in investment banking where he led the analysis on over 50 board advisory engagements involving mergers and acquisitions, fairness opinions and solvency opinions. Some of his board advisory highlights:
- Sears Holdings Corp.’s $620 mm spin-off via rights offering of Sears Outlet, Hometown Stores and Sears Hardware Stores.
- Cerberus Capital Management’s $3.3 bn acquisition of SUPERVALU Inc.’s New Albertsons, Inc. assets.
Andy can be reached at email@example.com.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.