Does SeaChange International Inc’s (NASDAQ:SEAC) PE Ratio Warrant A Buy?
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
SeaChange International Inc (NASDAQ:SEAC) trades with a trailing P/E of 4.4x, which is lower than the industry average of 51.9x. While SEAC might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for SeaChange International
Demystifying the P/E 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 SEAC
Price-Earnings Ratio = Price per share ÷ Earnings per share
SEAC Price-Earnings Ratio = $1.65 ÷ $0.378 = 4.4x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SEAC, 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. At 4.4, SEAC’s P/E is lower than its industry peers (51.9). This implies that investors are undervaluing each dollar of SEAC’s earnings. This multiple is a median of profitable companies of 24 Software companies in US including ZIM, Alfa Financial Software Holdings and Avaya Holdings. One could put it like this: the market is pricing SEAC as if it is a weaker company than the average company in its industry.
A few caveats
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to SEAC, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with SEAC, 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 SEAC to are fairly valued by the market. If this does not hold true, SEAC’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on SEAC, the undervaluation of the stock may mean it is a good time to top up on 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 SEAC’s future growth? Take a look at our free research report of analyst consensus for SEAC’s outlook.
Past Track Record: Has SEAC 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 SEAC’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 editorial-team@simplywallst.com.
