Intevac Inc (NASDAQ:IVAC) is currently trading at a trailing P/E of 36.9x, which is higher than the industry average of 18.7x. While this makes IVAC appear like a stock to avoid or sell if you own it, 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 Intevac
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 IVAC
Price-Earnings Ratio = Price per share ÷ Earnings per share
IVAC Price-Earnings Ratio = $7.05 ÷ $0.191 = 36.9x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to IVAC, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 36.9x, IVAC’s P/E is higher than its industry peers (18.7x). This implies that investors are overvaluing each dollar of IVAC’s earnings. As such, our analysis shows that IVAC represents an over-priced stock.
A few caveats
However, before you rush out to sell your IVAC shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to IVAC. 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 IVAC, 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 IVAC to are fairly valued by the market. If this does not hold true, IVAC’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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.