ASM International NV (ENXTAM:ASM) is currently trading at a trailing P/E of 7.8x, which is lower than the industry average of 25.3x. While this makes ASM 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. See our latest analysis for ASM International
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 ASM
Price-Earnings Ratio = Price per share ÷ Earnings per share
ASM Price-Earnings Ratio = €59.86 ÷ €7.724 = 7.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ASM, 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. At 7.8x, ASM’s P/E is lower than its industry peers (25.3x). This implies that investors are undervaluing each dollar of ASM’s earnings. Therefore, according to this analysis, ASM is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy ASM immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ASM, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with ASM, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing ASM to are fairly valued by the market. If this does not hold true, ASM’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on ASM, 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 ASM’s future growth? Take a look at our free research report of analyst consensus for ASM’s outlook.
- Past Track Record: Has ASM 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 ASM’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.