Data I/O Corporation (NASDAQ:DAIO) trades with a trailing P/E of 12.6x, which is lower than the industry average of 23.8x. 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 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 Data I/O
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 DAIO
Price-Earnings Ratio = Price per share ÷ Earnings per share
DAIO Price-Earnings Ratio = $8.45 ÷ $0.669 = 12.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as DAIO, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since DAIO’s P/E of 12.6x is lower than its industry peers (23.8x), it means that investors are paying less than they should for each dollar of DAIO’s earnings. Therefore, according to this analysis, DAIO is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy DAIO, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to DAIO. 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 DAIO, 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 DAIO to are fairly valued by the market. If this is violated, DAIO’s P/E may be lower than its peers as they are actually overvalued by investors.
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.