This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.
Kulicke and Soffa Industries Inc (NASDAQ:KLIC) is trading with a trailing P/E of 22.5, which is higher than the industry average of 19.1. While this might not seem positive, 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.
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 KLIC
Price-Earnings Ratio = Price per share ÷ Earnings per share
KLIC Price-Earnings Ratio = $21.92 ÷ $0.972 = 22.5x
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 KLIC, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since KLIC’s P/E of 22.5 is higher than its industry peers (19.1), it means that investors are paying more for each dollar of KLIC’s earnings. This multiple is a median of profitable companies of 25 Semiconductor companies in US including Daqo New Energy, Amtech Systems and Micron Technology. You could also say that the market is suggesting that KLIC is a stronger business than the average comparable company.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to KLIC. If not, the difference in P/E might be a result of other factors. For example, Kulicke and Soffa Industries Inc could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to KLIC may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
What this means for you:
Since you may have already conducted your due diligence on KLIC, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 KLIC’s future growth? Take a look at our free research report of analyst consensus for KLIC’s outlook.
- Past Track Record: Has KLIC 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 KLIC’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.