YuMe Inc (NYSE:YUME) is currently trading at a trailing P/E of 15x, which is lower than the industry average of 25.7x. 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for YuMe
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 YUME
Price-Earnings Ratio = Price per share ÷ Earnings per share
YUME Price-Earnings Ratio = $3.7 ÷ $0.247 = 15x
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 YUME, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 15x, YUME’s P/E is lower than its industry peers (25.7x). This implies that investors are undervaluing each dollar of YUME’s earnings. As such, our analysis shows that YUME represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy YUME immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to YUME, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with YUME, 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 YUME to are fairly valued by the market. If this does not hold, there is a possibility that YUME’s P/E is lower because our peer group is 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.