Altaba Inc (NASDAQ:AABA) is trading with a trailing P/E of 3x, which is lower than the industry average of 32.3x. 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Altaba
Breaking down the P/E ratio
P/E is a popular ratio used for relative valuation. 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 AABA
Price-Earnings Ratio = Price per share ÷ Earnings per share
AABA Price-Earnings Ratio = $81.62 ÷ $26.834 = 3x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to AABA, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. AABA’s P/E of 3x is lower than its industry peers (32.3x), which implies that each dollar of AABA’s earnings is being undervalued by investors. Therefore, according to this analysis, AABA is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy AABA immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to AABA, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with AABA, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing AABA to are fairly valued by the market. If this does not hold, there is a possibility that AABA’s P/E is lower because our peer group is 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 AABA 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 AABA’s future growth? Take a look at our free research report of analyst consensus for AABA’s outlook.
- Past Track Record: Has AABA 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 AABA’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 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.