I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
ATA Inc (NASDAQ:ATAI) trades with a trailing P/E of 3.7x, which is lower than the industry average of 24x. While ATAI might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
What you need to know about 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 ATAI
Price-Earnings Ratio = Price per share ÷ Earnings per share
ATAI Price-Earnings Ratio = CN¥8.17 ÷ CN¥2.194 = 3.7x
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 ATAI, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since ATAI’s P/E of 3.7 is lower than its industry peers (24), it means that investors are paying less for each dollar of ATAI’s earnings. This multiple is a median of profitable companies of 24 Consumer Services companies in US including Kid Castle Educational, H&R Block and Laureate Education. You can think of it like this: the market is suggesting that ATAI is a weaker business than the average comparable company.
Assumptions to be aware of
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to ATAI. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with ATAI, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing ATAI to are fairly valued by the market. If this is violated, ATAI’s P/E may be lower than its peers as they are actually overvalued by investors.
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 ATAI 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for ATAI’s future growth? Take a look at our free research report of analyst consensus for ATAI’s outlook.
- Past Track Record: Has ATAI 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 ATAI’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 past 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. For errors that warrant correction please contact the editor at email@example.com.