Should You Buy Facebook Inc (NASDAQ:FB) At This PE Ratio?
Facebook Inc (NASDAQ:FB) trades with a trailing P/E of 29.8x, which is lower than the industry average of 30.6x. While this makes FB appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Facebook
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in 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 FB
Price-Earnings Ratio = Price per share ÷ Earnings per share
FB Price-Earnings Ratio = $183.2 ÷ $6.144 = 29.8x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 FB, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. FB’s P/E of 29.8x is lower than its industry peers (30.6x), which implies that each dollar of FB’s earnings is being undervalued by investors. As such, our analysis shows that FB represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy FB, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to FB, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with FB, 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 FB to are fairly valued by the market. If this does not hold true, FB’s lower P/E ratio may be because firms in our peer group are 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 FB 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 FB’s future growth? Take a look at our free research report of analyst consensus for FB’s outlook.
Past Track Record: Has FB 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 FB’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.
