Accenture Plc (NYSE: ACN), an information technology firm with a market capitalization of $99.2 billion, currently trades at a P/E multiple of 27.8x which is below the sector’s median multiple of 30.3x. Although this makes ACN look attractive, investors may change their mind after reviewing the assumptions behind the P/E ratio. In the post below, I explain how to apply P/E multiples and what to watch out for.
How To Utilize Accenture’s PE Multiples
A multiples valuation, also known as a comparable companies analysis, determines the value of a subject company by benchmarking the subject’s financial performance against companies deemed to be similar. We can then determine if a company is undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation multiples.
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 Accenture’s P/E ratio to its peer group that includes DXC Technology Company (NYSE: DXC), International Business Machines Corporation (NYSE: IBM), Luxoft Holding, Inc. (NYSE: LXFT) and Infosys Limited (NYSE: INFY).
Since Accenture’s P/E ratio of 27.8x is higher than the median of its peers (21.3x), it means that investors are paying more than they should for each dollar of ACN’s earnings. As such, our analysis shows that ACN represents an overvalued stock. Furthermore, finbox.io’s P/E Ratio Model calculates a fair value of $124.71 per share which implies -19.2% downside.
I selected a fair multiple of 22.5x in my analysis by averaging Accenture’s current P/E ratio with its peer group.
The P/E Ratio’s Flaws
While this approach typically provides a reasonable valuation range, it is important to understand that our conclusion rests on some important assumptions. The first being that the selected peer group actually contains companies that truly are similar to Accenture. The second important assumption is that the selected peer group stocks are being fairly valued by the market.
If the assumptions above do not hold to be true, then the difference in P/E ratios could be due to a variety of factors. For example, if you accidentally compare Accenture with lower growth companies, then its P/E multiple would naturally be higher than its peers since investors reward high growth stocks with a higher price.
source: P/E model
On the other hand, if the second assumption does not hold true, Accenture’s higher multiple may be because our selected comparable companies are being undervalued by the market.
What To Do Next
As a current investor, you may have already conducted fundamental analysis on the company and its stock so its current overvaluation could signal a potential selling opportunity to reduce your exposure to ACN. But keep in mind the P/E ratio’s potential flaws when applying this valuation approach. It is important to note that there are a variety of other fundamental factors that I have not taken into consideration in this article. I highly recommend that you continue your research on Accenture by taking a look at the following:
Valuation Metrics: what is Accenture’s EBITDA less CapEx multiple and how does it compare to its peers? This is a helpful multiple to analyze when comparing capital intensive businesses. View the company’s EBITDA less CapEx multiple here.
Risk Metrics: what is Accenture’s asset efficiency? This ratio measures the amount of cash flow that a company generates from its assets. View the company’s asset efficiency here.
Efficiency Metrics: is management becoming more or less efficient in creating value for the firm? Find out by analyzing the company’s return on invested capital ratio 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 firstname.lastname@example.org.
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.