Does Microchip Technology Incorporated’s (NASDAQ:MCHP) PE Ratio Warrant A Sell?
Microchip Technology Incorporated (NASDAQ:MCHP) is currently trading at a trailing P/E of 82.8x, which is higher than the industry average of 25.1x. While this makes MCHP 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 Microchip Technology
Breaking down the Price-Earnings 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 MCHP
Price-Earnings Ratio = Price per share ÷ Earnings per share
MCHP Price-Earnings Ratio = $88.5 ÷ $1.068 = 82.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to MCHP, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. MCHP’s P/E of 82.8x is higher than its industry peers (25.1x), which implies that each dollar of MCHP’s earnings is being overvalued by investors. Therefore, according to this analysis, MCHP is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your MCHP shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to MCHP. 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 MCHP, 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 MCHP to are fairly valued by the market. If this does not hold true, MCHP’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.
