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Does AeroCentury Corp’s (NYSEMKT:ACY) PE Ratio Signal A Buying Opportunity?

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The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

AeroCentury Corp (NYSEMKT:ACY) is trading with a trailing P/E of 3.3x, which is lower than the industry average of 16.4x. 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.

See our latest analysis for AeroCentury

Breaking down the P/E ratio

AMEX:ACY PE PEG Gauge September 24th 18
AMEX:ACY PE PEG Gauge September 24th 18

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 ACY

Price-Earnings Ratio = Price per share ÷ Earnings per share

ACY Price-Earnings Ratio = $15.7 ÷ $4.687 = 3.3x

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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ACY, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since ACY’s P/E of 3.3 is lower than its industry peers (16.4), it means that investors are paying less for each dollar of ACY’s earnings. This multiple is a median of profitable companies of 24 Trade Distributors companies in US including Star Struck, APAC Resources and Willis Lease Finance. One could put it like this: the market is pricing ACY as if it is a weaker company than the average company in its industry.

Assumptions to be aware of

Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to ACY. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with ACY, 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 ACY to are fairly valued by the market. If this does not hold, there is a possibility that ACY’s P/E is lower because our peer group is 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 ACY 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 highly recommend you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for ACY’s future growth? Take a look at our free research report of analyst consensus for ACY’s outlook.

  2. Past Track Record: Has ACY 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 ACY’s historicals for more clarity.

  3. 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 editorial-team@simplywallst.com.