When Should You Buy Medallion Financial Corp (MFIN)?
Medallion Financial Corp (NASDAQ:MFIN) is currently trading at a trailing P/E of 6.2x, which is lower than the industry average of 18.6x. While this makes MFIN appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 Medallion Financial
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 MFIN
Price-Earnings Ratio = Price per share ÷ Earnings per share
MFIN Price-Earnings Ratio = 2.17 ÷ 0.351 = 6.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to MFIN, 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. MFIN’s P/E of 6.2x is lower than its industry peers (18.6x), which implies that each dollar of MFIN’s earnings is being undervalued by investors. As such, our analysis shows that MFIN represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy MFIN, 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 MFIN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with MFIN, 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 MFIN to are fairly valued by the market. If this does not hold, there is a possibility that MFIN’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to MFIN. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If MFIN has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Medallion Financial for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
