Does WageWorks Inc’s (NYSE:WAGE) PE Ratio Warrant A Sell?
WageWorks Inc (NYSE:WAGE) is trading with a trailing P/E of 38.2x, which is higher than the industry average of 21.1x. While this makes WAGE 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. 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 WageWorks
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 WAGE
Price-Earnings Ratio = Price per share ÷ Earnings per share
WAGE Price-Earnings Ratio = $46.15 ÷ $1.208 = 38.2x
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 WAGE, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. WAGE’s P/E of 38.2x is higher than its industry peers (21.1x), which implies that each dollar of WAGE’s earnings is being overvalued by investors. Therefore, according to this analysis, WAGE is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your WAGE shares, 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 WAGE, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with WAGE, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing WAGE to are fairly valued by the market. If this is violated, WAGE’s P/E may be lower than its peers as they are actually overvalued by investors.
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.
