Does Key Technology Inc’s (NASDAQ:KTEC) PE Ratio Warrant A Sell?
Key Technology Inc (NASDAQ:KTEC) trades with a trailing P/E of 28.4x, which is higher than the industry average of 26.7x. While KTEC might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Key Technology
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. 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 KTEC
Price-Earnings Ratio = Price per share ÷ Earnings per share
KTEC Price-Earnings Ratio = $17.76 ÷ $0.625 = 28.4x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 KTEC, 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 KTEC’s P/E of 28.4x is higher than its industry peers (26.7x), it means that investors are paying more than they should for each dollar of KTEC’s earnings. As such, our analysis shows that KTEC represents an over-priced stock.
A few caveats
However, before you rush out to sell your KTEC 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 KTEC. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with KTEC, 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 KTEC to are fairly valued by the market. If this does not hold, there is a possibility that KTEC’s P/E is lower because our peer group is 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.
