Tetra Tech Inc (NASDAQ:TTEK) trades with a trailing P/E of 19.6x, which is higher than the industry average of 17.4x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, 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. See our latest analysis for Tetra Tech
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 TTEK
Price-Earnings Ratio = Price per share ÷ Earnings per share
TTEK Price-Earnings Ratio = $47.65 ÷ $2.427 = 19.6x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to TTEK, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 19.6x, TTEK’s P/E is higher than its industry peers (17.4x). This implies that investors are overvaluing each dollar of TTEK’s earnings. Therefore, according to this analysis, TTEK is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your TTEK shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to TTEK. 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 TTEK, 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 TTEK to are fairly valued by the market. If this is violated, TTEK’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on TTEK, 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 TTEK’s future growth? Take a look at our free research report of analyst consensus for TTEK’s outlook.
- Past Track Record: Has TTEK 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 TTEK’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 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.