Should You Buy Kennametal Inc (NYSE:KMT) At This PE Ratio?
Kennametal Inc (NYSE:KMT) is trading with a trailing P/E of 22.5x, which is lower than the industry average of 24.3x. 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. View our latest analysis for Kennametal
Breaking down the Price-Earnings 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 KMT
Price-Earnings Ratio = Price per share ÷ Earnings per share
KMT Price-Earnings Ratio = $40.05 ÷ $1.783 = 22.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to KMT, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 22.5x, KMT’s P/E is lower than its industry peers (24.3x). This implies that investors are undervaluing each dollar of KMT’s earnings. Therefore, according to this analysis, KMT is an under-priced stock.
A few caveats
Before you jump to the conclusion that KMT is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to KMT, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with KMT, 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 KMT to are fairly valued by the market. If this is violated, KMT’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on KMT, 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. 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 KMT’s future growth? Take a look at our free research report of analyst consensus for KMT’s outlook.
Past Track Record: Has KMT 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 KMT’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.
