At $10.56, Is Mastech Digital Inc (MHH) A Buy?
Mastech Digital Inc (AMEX:MHH) trades with a trailing P/E of 19.2x, which is lower than the industry average of 31.4x. 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for MHH
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. 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 MHH
Price per share = 10.56
Earnings per share = 0.55
∴ Price-Earnings Ratio = 10.56 ÷ 0.55 = 19.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against 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 MHH, 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.
Since MHH's P/E of 19.2x is lower than its industry peers (31.4x), it means that investors are paying less than they should for each dollar of MHH's earnings. As such, our analysis shows that MHH represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy MHH immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to MHH. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with MHH, then investors would naturally value MHH at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with MHH, investors would also value MHH at a lower price since it is a lower growth investment. Both scenarios would explain why MHH has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing MHH to are fairly valued by the market. If this assumption does not hold true, MHH’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on MHH, 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.
Are you a potential investor? If you are considering investing in MHH, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Mastech Digital for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass 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.
