This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Atrion Corporation (NASDAQ:ATRI) is currently trading at a trailing P/E of 37.4x, which is lower than the industry average of 54.3x. While ATRI 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.
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 ATRI
Price-Earnings Ratio = Price per share ÷ Earnings per share
ATRI Price-Earnings Ratio = $684.46 ÷ $18.296 = 37.4x
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 ATRI, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since ATRI’s P/E of 37.4 is lower than its industry peers (54.3), it means that investors are paying less for each dollar of ATRI’s earnings. This multiple is a median of profitable companies of 24 Medical Equipment companies in US including Escalon Medical, Lantheus Holdings and FONAR. You can think of it like this: the market is suggesting that ATRI is a weaker business than the average comparable company.
A few caveats
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 ATRI. 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 ATRI, 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 ATRI to are fairly valued by the market. If this does not hold, there is a possibility that ATRI’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 ATRI 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:
- Future Outlook: What are well-informed industry analysts predicting for ATRI’s future growth? Take a look at our free research report of analyst consensus for ATRI’s outlook.
- Past Track Record: Has ATRI 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 ATRI’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 email@example.com.