Taylor Devices Inc (NASDAQ:TAYD) is currently trading at a trailing P/E of 19.8x, which is lower than the industry average of 27.7x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, 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 Taylor Devices
Demystifying 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 TAYD
Price-Earnings Ratio = Price per share ÷ Earnings per share
TAYD Price-Earnings Ratio = 13.44 ÷ 0.679 = 19.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as TAYD, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since TAYD's P/E of 19.8x is lower than its industry peers (27.7x), it means that investors are paying less than they should for each dollar of TAYD's earnings. Therefore, according to this analysis, TAYD is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy TAYD, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to TAYD, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with TAYD, 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 TAYD to are fairly valued by the market. If this does not hold true, TAYD’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on TAYD, 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.
Are you a potential investor? If you are considering investing in TAYD, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Taylor Devices for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.