MagnaChip Semiconductor Corporation (NYSE:MX) is trading with a trailing P/E of 8.7x, which is lower than the industry average of 24.6x. While MX 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for MagnaChip Semiconductor
Demystifying 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.
P/E Calculation for MX
Price-Earnings Ratio = Price per share ÷ Earnings per share
MX Price-Earnings Ratio = $11.25 ÷ $1.29 = 8.7x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as MX, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. MX’s P/E of 8.7x is lower than its industry peers (24.6x), which implies that each dollar of MX’s earnings is being undervalued by investors. Therefore, according to this analysis, MX is an under-priced stock.
A few caveats
However, before you rush out to buy MX, 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 MX, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with MX, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing MX to are fairly valued by the market. If this is violated, MX’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 MX, 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for MX’s future growth? Take a look at our free research report of analyst consensus for MX’s outlook.
- Past Track Record: Has MX 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 MX’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.