What Does Aspen Technology Inc’s (NASDAQ:AZPN) PE Ratio Tell You?
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 start learning about core concepts of fundamental analysis on practical examples from today’s market.
Aspen Technology Inc (NASDAQ:AZPN) is currently trading at a trailing P/E of 57.5, which is higher than the industry average of 51.7. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
Check out our latest analysis for Aspen Technology
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 AZPN
Price-Earnings Ratio = Price per share ÷ Earnings per share
AZPN Price-Earnings Ratio = $118.6 ÷ $2.061 = 57.5x
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 AZPN, 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. Since AZPN’s P/E of 57.5 is higher than its industry peers (51.7), it means that investors are paying more for each dollar of AZPN’s earnings. This multiple is a median of profitable companies of 25 Software companies in US including ZIM, Alfa Financial Software Holdings and Avaya Holdings. You could think of it like this: the market is pricing AZPN as if it is a stronger company than the average of its industry group.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to AZPN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Aspen Technology Inc is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with AZPN are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
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 rebalance your portfolio and reduce your holdings in AZPN. 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for AZPN’s future growth? Take a look at our free research report of analyst consensus for AZPN’s outlook.
Past Track Record: Has AZPN 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 AZPN’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 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.
